The Uncovered Return Parity Condition

52 Pages Posted: 27 Sep 2007

See all articles by Lorenzo Cappiello

Lorenzo Cappiello

European Central Bank (ECB)

Roberto A. De Santis

European Central Bank (ECB) - Directorate General Economics

Date Written: September 2007

Abstract

This paper proposes an equilibrium relationship between expected exchange rate changes and differentials in expected returns on risky assets. We show that when expected returns on a risky asset in a certain economy are higher than the returns that are expected from investing in a risky asset in another economy, then the currency corresponding to the economy whose asset offers higher returns is expected to depreciate. Due to its similarity with Uncovered Interest Parity (UIP), we call this equilibrium condition "Uncovered Return Parity" (URP). However, in the URP condition returns' differentials are not known ex ante, while in the UIP they are. The paper finds empirical support in favor of URP for certain markets over some sample periods.

Keywords: Uncovered Interest Parity, Uncovered Return Parity, stochastic discount factor, GMM

JEL Classification: F30, F31, G12, C32

Suggested Citation

Cappiello, Lorenzo and De Santis, Roberto A., The Uncovered Return Parity Condition (September 2007). ECB Working Paper No. 812. Available at SSRN: https://ssrn.com/abstract=1011150

Lorenzo Cappiello (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 8765 (Phone)

Roberto A. De Santis

European Central Bank (ECB) - Directorate General Economics ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

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