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Common and Idiosyncratic Factors of the Exchange Risk Premium in Emerging European Markets

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  • Byrne, Joseph P.
  • Nagayasu, Jun

Abstract

Existing empirical evidence suggests that the Uncovered Interest Rate Parity (UIRP) condition may not hold due to an exchange risk premium. For a panel data set of eleven emerging European economies we decompose this exchange risk premium into an idiosyncratic (country-specific) elements and a common factor using a principal components approach. We present evidence of a stationary idiosyncratic component and nonstationary common factor. This result leads to the conclusion of a nonstationary risk premium for these countries and a violation of the UIRP in the long-run, which is in contrast to previous studies often documenting a stationary premium in developed countries. Furthermore, we report that the variation in the premium is largely attributable to a common factor influenced by economic developments in the United States.

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Paper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2008-49.

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Date of creation: 2008
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Handle: RePEc:edn:sirdps:62

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Keywords: Uncovered Interest Rate Parity; Emerging Economies; Exchange Risk; Common Factors;

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Cited by:
  1. Nandini Srivastava & Stephen Satchell, 2012. "Are There Bubbles in the Art Market? The Detection of Bubbles when Fair Value is Unobservable," Birkbeck Working Papers in Economics and Finance 1209, Birkbeck, Department of Economics, Mathematics & Statistics.

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