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Uncovered Interest Parity in a Partially Dollarized Developing Country: Does UIP Hold in Bolivia? (And If Not, Why Not?)

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  • Melander, Ola

    ()
    (International Monetary Fund)

Abstract

According to the Uncovered Interest Parity (UIP) condition, interest rate differentials compensate for expected exchange rate changes, equalizing the expected returns from holding assets which only differ in terms of currency denomination. In the previous literature, there are many tests of UIP for industrialized countries, and, more recently, some tests for emerging economies. However, due to data availability problems, poorer developing countries have not been studied. This paper tests UIP in a partially dollarized economy, Bolivia, where bank accounts only differ in terms of currency denomination (U.S. dollars or bolivianos). I find that UIP does not hold in Bolivia, but that the deviations are smaller than in most other studies of developed and emerging economies. Moreover, several factors seem to contribute to the deviations from UIP. The so-called peso problem could possibly account for the observed data, but there is also evidence of a time-varying risk premium, as well as deviations from rational expectations.

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Bibliographic Info

Paper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 716.

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Length: 28 pages
Date of creation: 17 Apr 2009
Date of revision: 30 Jul 2009
Handle: RePEc:hhs:hastef:0716

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Related research

Keywords: Uncovered interest parity; UIP; partial dollarization; time-varying risk premium; peso problem; rational expectations;

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Cited by:
  1. Aysun, Uluc & Lee, Sanglim, 2014. "Can time-varying risk premiums explain the excess returns in the interest rate parity condition?," Emerging Markets Review, Elsevier, vol. 18(C), pages 78-100.
  2. Li, Dandan & Ghoshray, A. & Morley, B., 2011. "Uncovered Interest Parity and the Risk Premium," Department of Economics Working Papers 24072, University of Bath, Department of Economics.
  3. Uluc Aysun & Sanglim Lee, 2013. "The determinants of the deviations from the interest rate parity condition," Working Papers 2013-03, University of Central Florida, Department of Economics.

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