Breaking the UIP: A Model-Equivalence Result

Yossi Yakhin

doi:10.1111/jmcb.12883

Breaking the UIP: A Model-Equivalence Result

Yossi Yakhin

Research output: Contribution to journal › Article › peer-review

Abstract

Breaking the uncovered interest rate parity (UIP) is essential to accounting for exchange rate dynamics, and is required for modeling sterilized foreign exchange interventions. Gabaix and Maggiori (2015) account for many exchange rate puzzles by introducing financial intermediaries that absorb savings imbalances for a premium, thereby deviating from the UIP. Fanelli and Straub (2021) analyze foreign exchange interventions. In their model, regulatory exposure limits and participation cost in the international financial markets drive a wedge in the UIP. This paper demonstrates that, to a first-order approximation, introducing a reduced-form portfolio adjustment cost is isomorphic to these modeling strategies.

Original language	English
Pages (from-to)	1889-1904
Number of pages	16
Journal	Journal of Money, Credit and Banking
Volume	54
Issue number	6
DOIs	https://doi.org/10.1111/jmcb.12883
State	Published - 1 Sep 2022
Externally published	Yes

Keywords

UIP
financial frictions
open economy macroeconomics

ASJC Scopus subject areas

Accounting
Finance
Economics and Econometrics

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10.1111/jmcb.12883

Cite this

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title = "Breaking the UIP: A Model-Equivalence Result",

abstract = "Breaking the uncovered interest rate parity (UIP) is essential to accounting for exchange rate dynamics, and is required for modeling sterilized foreign exchange interventions. Gabaix and Maggiori (2015) account for many exchange rate puzzles by introducing financial intermediaries that absorb savings imbalances for a premium, thereby deviating from the UIP. Fanelli and Straub (2021) analyze foreign exchange interventions. In their model, regulatory exposure limits and participation cost in the international financial markets drive a wedge in the UIP. This paper demonstrates that, to a first-order approximation, introducing a reduced-form portfolio adjustment cost is isomorphic to these modeling strategies.",

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Breaking the UIP: A Model-Equivalence Result

Abstract

Keywords

ASJC Scopus subject areas

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