The determinants of the deviations from the interest rate parity condition

This paper shows that the deviation from the uncovered interest parity (UIP) condition is equally large in advanced and emergingmarket economies. Using monthly data, and a GARCH-M model we find that a large share of these deviations in both country groups are explained by time varying risk premium. To more clearly identify risk premium shocks, we then estimate a two country, New Keynesian, DSGE model using a Bayesian methodology and quarterly data. The results suggest that at the quarterly frequency, the large deviations from the UIP condition and the high explanatory power of risk premium is only observed for emerging market economies.