Working Paper: NBER ID: w28923
Authors: Ebnem Kalemlizcan; Liliana Varela
Abstract: We uncovered 5 novel facts on Uncovered Interest Parity (UIP) deviations for 22 emerging markets (EM). The average UIP premium—or the excess currency return—is: 1) always positive with large time-varying volatility; 2) correlates negatively with capital flows; 3) co-moves with global risk sentiments. 4) Using realized exchange rate changes or expected changes from survey data delivers the same result. 5) Policy uncertainty is the underlying primitive, capturing the high-frequency-variation in the UIP deviations, since country and currency risk are both captured by the interest rate differentials. Only fact (3) holds for advanced countries’ excess currency returns.
Keywords: uncovered interest parity; UIP premium; emerging markets; policy uncertainty
JEL Codes: E00; F00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Declining capital inflows (F32) | higher UIP premium (G52) |
| Policy uncertainty (D89) | UIP premium (G52) |
| Policy uncertainty (D89) | currency risk and returns (F31) |
| Global risk sentiments (F65) | excess returns in EMs (F31) |
| Policy uncertainty (D89) | excess currency returns (F31) |
| Capital flows (F32) | UIP deviations (L15) |
| Global risk sentiments (F65) | UIP deviations (L15) |