Common factors of the exchange risk premium in emerging european markets

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Byrne, Joseph P. and Nagayasu, Jun (2012) Common factors of the exchange risk premium in emerging european markets. Bulletin of Economic Research, 64 (S1). s71-s85. ISSN 0307-3378 (https://doi.org/10.1111/j.1467-8586.2012.00447.x)

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Abstract

Existing empirical evidence suggests that the Uncovered Interest Rate Parity condition may not hold due to an exchange risk premium. For a panel dataset of eleven emerging European economies we decompose this exchange risk premium into an idiosyncratic (country-specific) element and a common factor using a principal components approach. We present evidence of stationary idiosyncratic and common factors. This result leads to the conclusion of a stationary risk premium for these countries, which is consistent with previous studies often documenting a stationary premium in advanced countries. Furthermore, we report that the variation in the premium is largely attributable to a common factor influenced by economic developments in the United States.

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