decrease in the UIP slope coefficient over the period March 1979-March 1994. Hence, this
implies that the unfavorable evidence for the UIP condition for these economies may be
attributable to the inclusion of the pre-realignment dates during which the peso problem is
likely to prevail. Unlike Flood and Rose who analyze the slope term, Sachsida et al. (2001)
examine the intercept term in equation (3a), since the presence of a significant intercept
estimate may imply a risk premium that can be attributable to the peso problem. Their
analysis of Brazil for the period 1984-1998, indeed, implies a higher intercept estimate for
the period 1994-1998 that coincides with the Real Plan, indicating the possibility of the
peso problem in this period. Carvalho et al. (2004) include other Latin American countries
such as Argentina, Chile and Mexico and report that the country-specific intercept term
for Brazil decreases as the sample covers the flexible regime period of 1999-2001. This can
imply the presence of peso problem for Brazil in the pre-floating regime period.
The extent of the peso problem for emerging markets within the context of the UIP
condition seems to be a relatively unexplored area of research. This is because the market
expectations should be modeled explicitly and different states of the economy should be
identified appropriately to account for the peso problem. In addition, since it is not only
the exchange rate regime change, but also policy changes that have implications on macroe-
conomic fundamentals, further research on the peso problem in emerging markets should
also consider policy changes as well. In this sense, exploring country-specific financial in-
struments that can significantly reflect the market sentiment about policy change (Sercu
and Vinaimont, 2006), or analyzing monetary policy announcements that may signal future
states of the economy (Kaminsky, 1993) may provide valuable insights.
3.3 Monetary Policy Actions and the Uncovered Interest Parity
The third difference between the emerging markets and the developed economies within
the UIP context is that the likelihood of the simultaneity bias which is induced by central
banks’ tendency to over-react to exchange rate movements is expected to be higher for
emerging markets. In other words, monetary authorities’ inclination to contain exchange
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