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

THE ECONOMICS OF UNCOVERED INTEREST PARITY
CONDITION FOR EMERGING MARKETS: A SURVEY

C. Emre Alper,* Oya Pinar Ardic and Salih Fendoglu

Department of Economics,Bogazici University, Bebek 34342, Istanbul, Turkey.

May 30, 2007

Abstract

Financial account liberalizations since the second half of the 1980s paved way for
the burgeoning literature that investigates foreign exchange market efficiency in emerg-
ing markets via testing for the uncovered interest parity (UIP) condition. This paper
provides a broad and critical survey on this recent literature as well as a general under-
standing on the topic through reviewing the related literature on developed economies
where recent methodological advances in time series econometrics have provided fa-
vorable results, questioning the previously documented UIP puzzle. The literature on
emerging markets suggests that these countries deserve a special treatment by taking
into account the existence of additional types of risk premia, high inflation episodes,
financial contagion, peso problem, simultaneity problem, asymmetricity, and the deter-
mination of de facto structural breaks.

Keywords. Uncovered Interest Parity; Forward Premium Bias; Emerging Markets.

JEL No. F31.

* Corresponding author. Tel: +90 (212) 359-7646. Fax: + 90 (212) 287-2453. E-mail: [email protected].

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