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Measuring the risk premium in uncovered interest parity using the component GARCH-M model

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  • Li, Dandan
  • Ghoshray, Atanu
  • Morley, Bruce

Abstract

The aim of this study is to analyze the potential risk premium inherent in the uncovered interest parity (UIP) condition. The component GARCH-in-mean model is used to measure the time-varying risk premium in UIP and separates the permanent and transitory risks. The results show that the risk premium is significant in most countries studied in this analysis. This suggests that risk is an important part of modeling exchange rates and needs to be considered in both empirical and theoretical models. In general, the results suggest that emerging countries work better in terms of UIP and the risk premium than developed countries.

Suggested Citation

  • Li, Dandan & Ghoshray, Atanu & Morley, Bruce, 2012. "Measuring the risk premium in uncovered interest parity using the component GARCH-M model," International Review of Economics & Finance, Elsevier, vol. 24(C), pages 167-176.
  • Handle: RePEc:eee:reveco:v:24:y:2012:i:c:p:167-176
    DOI: 10.1016/j.iref.2012.02.001
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    Cited by:

    1. Tervala, Juha, 2013. "Learning by devaluating: A supply-side effect of competitive devaluation," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 275-290.
    2. 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.
    3. Nils Herger, 2017. "Testing the interest parity condition with Irving Fisher's example of Indian rupee and sterling bonds in the London financial market (1869 - 1906)," Working Papers 17.04, Swiss National Bank, Study Center Gerzensee.
    4. José Renato Haas Ornelas, 2017. "Expected Currency Returns and Volatility Risk Premia," Working Papers Series 454, Central Bank of Brazil, Research Department.
    5. repec:eee:reveco:v:49:y:2017:i:c:p:255-265 is not listed on IDEAS
    6. Dejan Živkov & Jovan Njegić & Mirela Momčilović & Ivan Milenković, 2016. "Exchange Rate Volatility and Uncovered Interest Rate Parity in the European Emerging Economies," Prague Economic Papers, University of Economics, Prague, vol. 2016(3), pages 253-270.
    7. Jalali Naini, Ahmad Reza & Naderian, Mohammad Amin, 2017. "Financial Vulnerability and Stabilization Policy in Commodity Exporting Emerging Economies," MPRA Paper 84481, University Library of Munich, Germany.
    8. repec:cuf:journl:y:2017:v:18:i:1:asab is not listed on IDEAS
    9. Chu, Shiou-Yen, 2015. "Funding liquidity constraints and the forward premium anomaly in a DSGE model," International Review of Economics & Finance, Elsevier, vol. 39(C), pages 76-89.
    10. Goh, Soo Khoon & McNown, Robert, 2015. "Examining the exchange rate regime–monetary policy autonomy nexus: Evidence from Malaysia," International Review of Economics & Finance, Elsevier, vol. 35(C), pages 292-303.
    11. 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.
    12. repec:eee:ecofin:v:49:y:2019:i:c:p:206-234 is not listed on IDEAS
    13. Coelho dos Santos, Marcelo Bittencourt & Klotzle, Marcelo Cabus & Figueiredo Pinto, Antonio Carlos, 2016. "Evidence of risk premiums in emerging market carry trade currencies," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 44(C), pages 103-115.
    14. repec:wsi:afexxx:v:13:y:2018:i:02:n:s2010495218500094 is not listed on IDEAS
    15. repec:cbk:journl:v:7:y:2018:i:3:p:41-56 is not listed on IDEAS

    More about this item

    Keywords

    Risk premium; Uncovered interest parity; Component GARCH-in-mean;

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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