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Five Facts about the UIP Premium

Author

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  • Kalemli-Özcan, á¹¢ebnem
  • Varela, Liliana

Abstract

We present five novel facts on the UIP-wedge—the difference between expected USD returns on local currency assets and actual USD asset returns. We focus on emerging markets (EMs) and contrast our new findings with established ones for advanced economies (AEs). The five facts are: 1) Persistent EM-UIP Wedge: The EM-UIP wedge fluctuates but remains positive, indicating a continuous excess currency return both ex-ante and ex-post. 2) Expectation Accuracy: Survey data on agents’ expectations of future exchange rate changes closely align with actual outcomes, demonstrating similar dynamics and Fama coefficients for the EMUIP wedge. 3) Heterogenous Perceptions and Risk Factors: Disagreement among agents about future exchange rate movements is positively correlated with local risk factors and can forecast interest rate differentials. 4) Local Risk and Time-Variability: Local risk factors account for 70% of the variability in the EM-UIP wedge over time, driven by interest rate differentials. 5) Foreign Capital: The EM-UIP wedge relates to foreign investment, exhibiting a negative relationship with capital inflows. These findings underscore the nuanced behavior of the UIP wedge in EMs vs AEs, where EM-UIP wedge more closely reflects compensation for systematic, country-specific, and time-varying risk premia in segmented asset markets.

Suggested Citation

  • Kalemli-Özcan, á¹¢ebnem & Varela, Liliana, 2022. "Five Facts about the UIP Premium," CEPR Discussion Papers 16244, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16244
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    Cited by:

    1. Gole, Purva & Perego, Erica & Turcu, Camelia, 2024. "UIP deviations in times of uncertainty: Not all countries behave alike," Economics Letters, Elsevier, vol. 242(C).
    2. Engel, Charles & Bianchi, Javier & Bigio, Saki, 2021. "Scrambling for Dollars: International Liquidity, Banks and Exchange Rates," CEPR Discussion Papers 16712, C.E.P.R. Discussion Papers.
    3. Jeanne, Olivier, 2022. "Rounding the corners of the trilemma: A simple framework," Journal of International Money and Finance, Elsevier, vol. 122(C).
    4. Bernoth, Kerstin & Herwartz, Helmut & Trienens, Lasse, 2024. "Interest Rates, Convenience Yields and Inflation Expectations: Drivers of US Dollar Exchange Rates," VfS Annual Conference 2024 (Berlin): Upcoming Labor Market Challenges 302351, Verein für Socialpolitik / German Economic Association, revised 2024.
    5. Boermans, Martijn A. & Burger, John D., 2023. "Fickle emerging market flows, stable euros, and the dollar risk factor," Journal of International Economics, Elsevier, vol. 142(C).
    6. Miguel Acosta-Henao & Andrés Fernández & Patricia Gomez-Gonzalez & Sebnem Kalemli-Ozcan, 2022. "The COVID-19 Shock and Firm Financing: Government or Market? Or Both?," Working Papers Central Bank of Chile 967, Central Bank of Chile.
    7. Eugenio Cerutti & Haonan Zhou, 2024. "Uncovering CIP Deviations in Emerging Markets: Distinctions, Determinants, and Disconnect," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 72(1), pages 196-252, March.
    8. Gutierrez, Bryan & Ivashina, Victoria & Salomao, Juliana, 2023. "Why is dollar debt Cheaper? Evidence from Peru," Journal of Financial Economics, Elsevier, vol. 148(3), pages 245-272.
    9. Javier Bianchi & Guido Lorenzoni, 2021. "The Prudential Use of Capital Controls and Foreign Currency Reserves," NBER Working Papers 29476, National Bureau of Economic Research, Inc.
    10. Ekaterina Pirozhkova & Jeffrey Rakgalakane & Luchelle Soobyah & Rudi Steinbach, 2023. "Enhancing the Quarterly Projection Model," Working Papers 11048, South African Reserve Bank.
    11. Michael B. Devereux & Charles Engel & Steve Pak Yeung Wu, 2023. "Collateral Advantage: Exchange Rates, Capital Flows and Global Cycles," NBER Working Papers 31164, National Bureau of Economic Research, Inc.
    12. Matthieu Bussière & Menzie Chinn & Laurent Ferrara & Jonas Heipertz, 2022. "The New Fama Puzzle," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 70(3), pages 451-486, September.
    13. Paolo Manasse & Graziano Moramarco & Giulio Trigilia, 2024. "Exchange rates and political uncertainty: the Brexit case," Economica, London School of Economics and Political Science, vol. 91(362), pages 621-652, April.
    14. Ekaterina Pirozhkova & Jeffrey Rakgalakane & Luchelle Soobyah Rudi Steinbach, 2023. "EnhancingtheQuarterlyProjectionModel," Working Papers 11044, South African Reserve Bank.

    More about this item

    Keywords

    Excess currency returns; Risk premia; Expectations; Policy credibility;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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