The Economics of Uncovered Interest Parity Condition for Emerging Markets: A Survey

Source: Bekaert et al. (2002) and country sources.

Table 1: De jure liberalization dates of major emerging markets

take the structural differences between emerging markets and developed economies into
account in their estimations, and contrary to initial expectations, document less unfavorable
results for emerging markets. In particular, Bansal and Dahlquist (2000) study a total of 28
developed and emerging economies using monthly data for the period 1976-1998 and report
that UIP deviations lessen for countries with lower per capita GNP, lower credit ratings,
higher average inflation and higher inflation volatility. Using higher data frequencies, Flood
and Rose (2002) test for the UIP condition for 13 developed and 10 emerging market
economies for the 1990s and also report favorable results for high-inflation economies and
those countries who experience at least one exchange rate regime switch throughout the
sample period. Using forward market data for emerging markets, Frankel and Poonawala
(2006) analyze the forward premium bias explicitly for a set of 21 developed and emerging
market economies for the period December 1996-April 2004 and document that forward
premium bias is less severe in emerging markets.⁹

There are several issues arising from these studies: First, so far there is no empirical
support for the a priori expectation that UIP is less likely to hold in emerging markets. This
may be because of high inflation and easy-to-follow pattern of macroeconomic fundamentals
in emerging markets.¹⁰ Also, de jure capital controls in these markets may not be binding,
as emphasized by Kose (2006) and Carvalho and Garcia (2007). Second, the results seem

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