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COMMON FACTORS OF THE EXCHANGE RISK PREMIUM IN EMERGING EUROPEAN MARKETS

Authors


Joseph P. Byrne, Department of Economics, Business School, Adam Smith Building, Bute Gardens, University of Glasgow, Glasgow G12 8RT, UK. Tel: +44 (0)141 330 4617; Fax: +44 (0)141 330 4940; Email: joseph.byrne@glasgow.ac.uk. We would like to thank two referees for providing helpful comments. Jun Nagayasu acknowledges financial support in the form of a Grant-in-Aid for Science Research, Kakenhi, Kiban Kenkyu (C) No. 21530206.

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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