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A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle

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  • Seungduck Lee

    (Department of Economics, Sungkyunkwan University, Seoul, Republic of Korea)

  • Kuk Mo Jung

    (Department of Economics, Sogang University, Seoul)

Abstract

A new monetary theory is set out to resolve the "Uncovered Interest Parity (UIP)" Puzzle. It explores the possibility that liquidity properties of money and nominal bonds can account for the puzzle. A key concept in our model is that nominal bonds carry liquidity premia. We show that the UIP can fail to hold under the economic environment where collateral pledgeability and/or liquidity of nominal bonds and/or collateralized credit based transactions are relatively bigger. Our liquidity based theory can help understanding many empirical observations that risk based explanations find difficult to reconcile with.

Suggested Citation

  • Seungduck Lee & Kuk Mo Jung, 2019. "A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle," Working Papers 1902, Nam Duck-Woo Economic Research Institute, Sogang University (Former Research Institute for Market Economy).
    • Handle: RePEc:sgo:wpaper:1902
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    References listed on IDEAS

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    1. Ca' Zorzi, Michele & Longaric, Pablo Anaya & Rubaszek, Michał, 2021. "The predictive power of equilibrium exchange rate models," Economic Bulletin Articles, European Central Bank, vol. 7.

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    More about this item

    Keywords

    uncovered interest parity puzzle; monetary search models; FOREX market;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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