A Liquidity-Based Resolution of the Uncovered Interest Parity Puzzle

Seungduck Lee, Kuk Mo Jung

Research output: Contribution to journalArticlepeer-review

2 Scopus citations

Abstract

A new monetary theory is set out to resolve the “uncovered interest parity (UIP)” puzzle. It explores the possibility that liquidity properties of money and nominal bonds can account for the puzzle. A key concept in our model is that nominal bonds carry liquidity premia. We show that the UIP can fail to hold under the economic environment where collateral pledgeability and/or liquidity of nominal bonds and/or collateralized credit-based transactions are relatively bigger. Our liquidity-based theory can help understanding many empirical observations that risk-based explanations find difficult to reconcile with.

Original languageEnglish
Pages (from-to)1397-1433
Number of pages37
JournalJournal of Money, Credit and Banking
Volume52
Issue number6
DOIs
StatePublished - 2020 Sep 1

Keywords

  • E31
  • E4
  • E52
  • F31
  • FOREX market
  • monetary search models
  • uncovered interest parity puzzle

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