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What Covered Interest Parity Implies about the Theory of Uncovered Interest Parity

  • Pippenger, John
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    The literature assumes that the theory of uncovered interest parity fails because investing without cover is risky and investors are risk adverse. But covered interest parity implies that the theory can fail even when investors are risk neutral and hold when investors are risk adverse and there is a risk premium. The failure to fully appreciate the relation between uncovered interest parity and risk premiums has probably contributed to our failure to understand why UIP fails empirically.

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    Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number qt0zk6t2hj.

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    Date of creation: 30 May 2012
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    Handle: RePEc:cdl:ucsbec:qt0zk6t2hj
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    1. Sarantis, Nicholas, 2006. "Testing the uncovered interest parity using traded volatility, a time-varying risk premium and heterogeneous expectations," Journal of International Money and Finance, Elsevier, vol. 25(7), pages 1168-1186, November.
    2. Felmingham, Bruce & Leong, SuSan, 2005. "Parity conditions and the efficiency of the Australian 90- and 180-day forward markets," Review of Financial Economics, Elsevier, vol. 14(2), pages 127-145.
    3. Akram, Q. Farooq & Rime, Dagfinn & Sarno, Lucio, 2008. "Arbitrage in the foreign exchange market: Turning on the microscope," Journal of International Economics, Elsevier, vol. 76(2), pages 237-253, December.
    4. Lucio Sarno & Paul Schneider & Christian Wagner, 2012. "Properties of Foreign Exchange Risk Premiums," Working Paper Series 10_12, The Rimini Centre for Economic Analysis.
    5. Chaboud, Alain P. & Wright, Jonathan H., 2005. "Uncovered interest parity: it works, but not for long," Journal of International Economics, Elsevier, vol. 66(2), pages 349-362, July.
    6. Frankel, Jeffrey A. & Poonawala, Jumana, 2009. "The Forward Market in Emerging Currencies: Less Biased than in Major Currencies," Scholarly Articles 4448888, Harvard Kennedy School of Government.
    7. Fong, Wai-Ming & Valente, Giorgio & Fung, Joseph K.W., 2010. "Covered interest arbitrage profits: The role of liquidity and credit risk," Journal of Banking & Finance, Elsevier, vol. 34(5), pages 1098-1107, May.
    8. Arnaud Mehl & Lorenzo Cappiello, 2009. "Uncovered Interest Parity at Long Horizons: Evidence on Emerging Economies ," Review of International Economics, Wiley Blackwell, vol. 17(5), pages 1019-1037, November.
    9. Richard T. Baillie & Rehim Kilic, 2005. "Do Asymmetric and Nonlinear Adjustments Explain the Forward Premium Anomaly?," Working Papers 543, Queen Mary University of London, School of Economics and Finance.
    10. Levent, Korap, 2010. "Does the uncovered interest parity hold in short horizons?," MPRA Paper 20788, University Library of Munich, Germany.
    11. Bing Han, 2004. "Is the forward premium puzzle universal?," Applied Economics Letters, Taylor & Francis Journals, vol. 11(2), pages 131-134.
    12. Hochradl, Markus & Wagner, Christian, 2010. "Trading the forward bias: Are there limits to speculation?," Journal of International Money and Finance, Elsevier, vol. 29(3), pages 423-441, April.
    13. Paya, Ivan & Peel, David A. & Spiru, Alina, 2010. "The forward premium puzzle in the interwar period and deviations from covered interest parity," Economics Letters, Elsevier, vol. 108(1), pages 55-57, July.
    14. Menzie D. Chinn & Guy Meredith, 2004. "Monetary Policy and Long-Horizon Uncovered Interest Parity," IMF Staff Papers, Palgrave Macmillan, vol. 51(3), pages 409-430, November.
    15. Philippe Bacchetta & Eric van Wincoop, 2010. "Infrequent Portfolio Decisions: A Solution to the Forward Discount Puzzle," American Economic Review, American Economic Association, vol. 100(3), pages 870-904, June.
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