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Deviations from interest rate parity in small open economies: A quantitative-theoretical investigation

  • Lorand Ambrus-Lakatos

    (Central European University)

  • Balazs Vilagi

    (Budapest University of Economic Sciences and Public Administration)

  • Janos Vincze

    ()

    (Budapest University of Economic Sciences and Public Administration)

It is frequently claimed that the expected yield on emerging market bonds commands a premium. Here we investigate the sources of this phe-nomenon. A stochastic general equilibrium model of a small open economy is analyzed numerically to derive conditions for interest rate premia. The novelty of our approach is to attack the problem form the point of view of state dependent policy mixes. The main lessons include: if positive premia were universal, then 1. nominal rigidity should be important, 2. monetary authorities might have a current account stabilization motive, and 3. taste shocks possibly play some role in emerging markets.

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File URL: http://www.econ.core.hu/doc/dp/dp/mtdp0403.pdf
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Paper provided by Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences in its series IEHAS Discussion Papers with number 0403.

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Length: 27 pages
Date of creation: Feb 2004
Date of revision:
Handle: RePEc:has:discpr:0403
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  1. Charles Engel, 1999. "On the Foreign Exchange Risk Premium in Sticky-Price General Equilibrium Models," International Tax and Public Finance, Springer, vol. 6(4), pages 491-505, November.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Working Paper Series, Macroeconomic Issues WP-96-28, Federal Reserve Bank of Chicago.
  3. Svensson, Lars E.O., 1998. "Open-Economy Inflation Targeting," Seminar Papers 638, Stockholm University, Institute for International Economic Studies.
  4. Monacelli, Tommaso, 2004. "Into the Mussa puzzle: monetary policy regimes and the real exchange rate in a small open economy," Journal of International Economics, Elsevier, vol. 62(1), pages 191-217, January.
  5. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, 08.
  6. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
  7. Fama, Eugene F., 1984. "Forward and spot exchange rates," Journal of Monetary Economics, Elsevier, vol. 14(3), pages 319-338, November.
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