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

Listed author(s):
  • Byrne, Joseph P.
  • Nagayasu, Jun

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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File URL: http://hdl.handle.net/10943/62
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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
Handle: RePEc:edn:sirdps:62
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