The Limits of Exchange Rate as Nominal Anchor : Evidence from the 1999-2005 Ukrainian Experience

Despite its adoption of a nominal-anchor exchange-rate policy during the period 1999-2005, Ukrainian financial markets were subject to substantial premia in interest rates on interbank markets relative to what is observed in Euro credit markets. In this paper I demonstrate that there were three independent premia, and that these sources had different causes. Estimation of a stochastic-discount-factor model using weekly data over the period 1999-2005 illustrates that the government’s “nominal anchor” policy vis à vis the US dollar was effective at eliminating the risk of currency depreciation. However, other risks related to convertibility and liquidity were either not addressed or exacerbated, and thus deviations from uncovered interest parity continued through the period. Future monetary and financial-sector policy should be calibrated to address all three