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A Liquidity‐Based Resolution of the Uncovered Interest Parity Puzzle

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  • SEUNGDUCK LEE
  • KUK MO JUNG

Abstract

A new monetary theory is set out to resolve the “uncovered interest parity (UIP)” puzzle. It explores the possibility that liquidity properties of money and nominal bonds can account for the puzzle. A key concept in our model is that nominal bonds carry liquidity premia. We show that the UIP can fail to hold under the economic environment where collateral pledgeability and/or liquidity of nominal bonds and/or collateralized credit‐based transactions are relatively bigger. Our liquidity‐based theory can help understanding many empirical observations that risk‐based explanations find difficult to reconcile with.

Suggested Citation

  • Seungduck Lee & Kuk Mo Jung, 2020. "A Liquidity‐Based Resolution of the Uncovered Interest Parity Puzzle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(6), pages 1397-1433, September.
    • Handle: RePEc:wly:jmoncb:v:52:y:2020:i:6:p:1397-1433
    DOI: 10.1111/jmcb.12663
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    2. Lucas Herrenbrueck, Zijian Wang, 2023. "Interest Rates, Moneyness, and the Fisher Equation," Discussion Papers dp23-11, Department of Economics, Simon Fraser University.
    3. Wang, Chenxi, 2023. "A model of international currency with private information," Journal of International Money and Finance, Elsevier, vol. 131(C).

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