Testing and Interpreting Uncovered Interest Parity in Russia
The failure of uncovered interest rate parity (UIP) is a well-known phenomenon in last thirty years. The failure of UIP is more prominent in advanced economies rather than in emerging market economies. Usually UIP estimation for an advanced economy gives negative coefficient, meaning that higher interest rate in the advanced economy A will result in the appreciation of the economy A’s exchange rate. In case of emerging market economies, higher interest rate usually corresponds to future depreciation, although this depreciation is not sufficient for UIP to hold. This paper shows that UIP holds in Russia even better than on average in other emerging market economies, if the UIP equation includes constant risk premium. Consequently, there is no forward premium puzzle in Russian data of 2001–2014. To show the results on Russia and compare them with the results on other countries, we estimate UIP, first, for Russia, and then for the advanced and emerging market economies, using seemingly unrelated regresions and panel data analysis. By comparing profitability of static and dynamic carry trade strategies, we also confirm that in the emerging market economies risk premium is often constant, whereas in the advanced economies risk premium is almost always volatile. This feature may explain why UIP holds better for emerging market economies. It also enables us to formulate the hypothesis saying that macroeconomic policy of the emerging market economies, such as the accumulation of large foreign exchange reserves, stabilize risk premium
Volume (Year): 4 (2016)
Issue (Month): (August)
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