ABSTRACTFisher Hypothesis implies a one-to-one long-term relationship betweennominal interest rate and inflation. Though this one-to-one relationship doesnot hold in most of the financial markets, there exists strong evidence for apartial relationship between the two variables. This study inquires into thelong-term relationship between nominal interest rate and inflation in thecontext of Sri Lankan financial markets. The study has two prime objectives.First, it examines the nature of the relationship between nominal interest rateand inflation in Sri Lanka. Second, it investigates whether there existdifferences in this relationship across different frequencies of data such asmonthly, quarterly and annual. As an alternative to the various methodologiesused to test for Fisher Hypothesis with data for Sri Lanka, this study employsAutoregressive Distributed Lag bounds testing approach developed in Pesaran,Shin and Smith (2001). The main finding of the study is the evidence for theabsence of a long-term relationship between nominal interest rate and inflationin Sri Lankan financial markets.JEL Classification: E40, E43, E44, G10Key Words: Fisher Hypothesis, ARDL Models, Bounds Testing,Cointegration, Sri Lanka1. INTRODUCTIONFisher (1930) hypothesis postulates that there isa one-to-one relationship between nominalinterest rate and inflation assuming a constantreal rate of interest over the long term. However,this does not mean that real interest rate is stableover time. The implication of the Fisherhypothesis is that the real rate of interest, thedifference between nominal interest rate and theinflation rate, is basically determined by the realfactors of the economy (Kinal and Lahiri, 1988).The one-to-one relationship between nominalinterest rate and the expected inflation and thefact that real interest rate is determined by realfactors also implies that the monetary policymeasures cannot influence the real interest rate(Carmichael and Stebbing, 1983).The presence of the Fisher effect in the financialmarkets has been a widely discussed topic.However, there is a dearth of studies that test forthe Fisher effect in the financial markets of SriLanka. As such, this study focuses on two primeobjectives. First, it attempts to examine thenature of the relationship between nominalinterest rates and inflation in Sri Lankanfinancial markets. Second, it investigateswhether the relationship between nominalinterest rates and inflation differs across differentfrequencies of data.The study is also warranted because the SriLankan government securities market andnominal interest rates have not been givenenough attention by the researchers despite thefact that the market is continuously growing insize, availability and quality of infrastructure,number of participants, and volume of trading.The structure of the study is as follows. Section 2provides a brief review of literature on Fisher