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A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle

Author

Listed:
  • 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, Research Institute for Market Economy, Sogang University.
  • Handle: RePEc:sgo:wpaper:1902
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    References listed on IDEAS

    as
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    Cited by:

    1. Mijakovic, Andrej & Rubaszek, Michał & Ca' Zorzi, Michele & Cap, Adam, 2020. "The predictive power of equilibrium exchange rate models," Working Paper Series 2358, European Central Bank.

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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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