Differential Risk Premiums and the UIP Puzzle

46 Pages Posted: 22 Jun 2017 Last revised: 4 Mar 2019

See all articles by Rita Biswas

Rita Biswas

University at Albany - SUNY

Louis R. Piccotti

Oklahoma State University - Stillwater - Spears School of Business

Ben Z. Schreiber

Bank of Israel; Bar Ilan University

Date Written: March 2, 2019

Abstract

We jointly re-specify the relative purchasing power parity (RPPP) and uncovered interest rate parity (UIP) conditions as the (log) ratio of stochastic discount factors by inverting the market price of risk formula. Our empirical model provides new insights, which show that violations to UIP and RPPP both stem from the existence of a risk premium in exchange rates and from observed market return differentials being a noisy statistic of the markets' expected return differentials in our re-specified model. Using an integrated macro-microstructure framework for expected market return differentials improves our model fit and the validity of UIP and RPPP.

Keywords: Foreign exchange market, Uncovered interest rate parity, Risk premium, Purchasing power parity

JEL Classification: F31, G14, G15

Suggested Citation

Biswas, Rita and Piccotti, Louis R. and Schreiber, Ben Z., Differential Risk Premiums and the UIP Puzzle (March 2, 2019). Available at SSRN: https://ssrn.com/abstract=2990363 or http://dx.doi.org/10.2139/ssrn.2990363

Rita Biswas

University at Albany - SUNY ( email )

1400 Washington Ave.
Albany, NY 12222
United States
518-442-4996 (Phone)
518-442-3045 (Fax)

Louis R. Piccotti (Contact Author)

Oklahoma State University - Stillwater - Spears School of Business ( email )

460 Business
Stillwater, OK 74078-0555
United States

Ben Z. Schreiber

Bank of Israel ( email )

P.O. Box 780
Jerusalem 91007
Israel
972-2-6552595 (Phone)
972-2-6512026 (Fax)

Bar Ilan University ( email )

Ramat Gan, 55000
Israel

Register to save articles to
your library

Register

Paper statistics

Downloads
58
rank
354,724
Abstract Views
920
PlumX Metrics