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Abstract
A large literature has related the failure of interest rate parity in the foreign exchange market to the existence of a time-varying risk premium. Nevertheless, most modern open economy DSGE models imply a (near) perfect interest rate parity condition. This paper presents a stylized two-country incomplete-markets model in which countries have
strong precautionary motives because they face international liquidity constraints, the presence of which successfully generates a time-varying risk premium: the country that has accumulated debt after experiencing relative worse times has stronger precautionary
motives and its asset carries a risk premium. (author's abstract)
strong precautionary motives because they face international liquidity constraints, the presence of which successfully generates a time-varying risk premium: the country that has accumulated debt after experiencing relative worse times has stronger precautionary
motives and its asset carries a risk premium. (author's abstract)
| Original language | English |
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| DOIs | |
| Publication status | Published - 1 Apr 2014 |
Publication series
| Series | Department of Economics Working Paper Series |
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| Number | 171 |
WU Working Paper Series
- Department of Economics Working Paper Series
Other versions
- 1 Journal article
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An Incomplete Markets Explanation of the UIP Puzzle
Rabitsch-Schilcher, K., 2016, In: Review of International Economics. 24, 2, p. 422 - 446Publication: Scientific journal › Journal article › peer-review