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Common and idiosyncratic factors of the exchange risk premium in emerging European markets

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

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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Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2008_28.

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Date of creation: Sep 2008
Handle: RePEc:gla:glaewp:2008_28
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