The Uncovered Return Parity Condition
52 Pages Posted: 27 Sep 2007
Date Written: September 2007
This paper proposes an equilibrium relationship between expected exchange rate changes and differentials in expected returns on risky assets. We show that when expected returns on a risky asset in a certain economy are higher than the returns that are expected from investing in a risky asset in another economy, then the currency corresponding to the economy whose asset offers higher returns is expected to depreciate. Due to its similarity with Uncovered Interest Parity (UIP), we call this equilibrium condition "Uncovered Return Parity" (URP). However, in the URP condition returns' differentials are not known ex ante, while in the UIP they are. The paper finds empirical support in favor of URP for certain markets over some sample periods.
Keywords: Uncovered Interest Parity, Uncovered Return Parity, stochastic discount factor, GMM
JEL Classification: F30, F31, G12, C32
Suggested Citation: Suggested Citation