SSE/EFI Working Paper Series in Economics and Finance
Uncovered Interest Parity in a Partially Dollarized Developing Country: Does UIP Hold in Bolivia? (And If Not, Why Not?)
Abstract: According to the Uncovered Interest Parity (UIP)
condition, interest rate differentials compensate for expected exchange
rate changes, equalizing the expected returns from holding assets which
only differ in terms of currency denomination. In the previous literature,
there are many tests of UIP for industrialized countries, and, more
recently, some tests for emerging economies. However, due to data
availability problems, poorer developing countries have not been studied.
This paper tests UIP in a partially dollarized economy, Bolivia, where bank
accounts only differ in terms of currency denomination (U.S. dollars or
bolivianos). I find that UIP does not hold in Bolivia, but that the
deviations are smaller than in most other studies of developed and emerging
economies. Moreover, several factors seem to contribute to the deviations
from UIP. The so-called peso problem could possibly account for the
observed data, but there is also evidence of a time-varying risk premium,
as well as deviations from rational expectations.
Keywords: Uncovered interest parity; UIP; partial dollarization; time-varying risk premium; peso problem; rational expectations; (follow links to similar papers)
JEL-Codes: E43; F31; G15; (follow links to similar papers)
28 pages, April 17, 2009, Revised July 30, 2009
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