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Ambiguity Aversion: Implications For The Uncovered Interest Rate Parity Puzzle

  • COSMIN ILUT

    (NORTHWESTERN UNIVERSITY)

positive domestic interest rate differential predicts that the domestic currency will appreciate in the future. The reason capital inflows into high-interest-rate currencies are limited in the model is that agents tend to overstate the probability of a future depreciation. I show that my result cannot be duplicated in a simple model with risk aversion. In addition to providing a resolution to the UIP puzzle, the model predicts, consistent with the data, negative skewness and excess kurtosis for carry trade payoffs and positive average payoffs even for hedged positions.

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Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 328.

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Date of creation: 2009
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Handle: RePEc:red:sed009:328
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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