The uncovered parity properties of the czech koruna

Abstract

The paper studies the compliance of the CZK -EUR exchange rate with the uncovered parity of returns on assets denominated in the two named currencies. A comparison with the same property for the euro-dollar rate is made. An uncovered total return parity (UTRP) formula is derived from the equilibrium in a portfolio optimization model with liquidity constraints. It is shown that the uncovered parity of total returns, and not of short-term money market rates, is a natural outcome of stochastic equilibrium asset pricing models that generalize the International Consumption-based Capital Asset Pricing Model. Accordingly, the traditional uncovered interest rate parity should be replaced by UTRP in empirical analysis. UTRP tests for the CZK/EUR and the USD/EMU currency pairs are conducted using yields of long-term government bond yields. UTRP typically holds, although the time horizons and measures of exchange rate movements, for which it becomes visible, may vary.

Exchange Rate Risks and Asset Prices in a Small Open Economy

“…Here, l 0 is a scalar constant, whereas l 1 and L are row vectors of dimension n. The observation equation system (6) together with the state equation system ( 7), ( 8) constitute the state-space representation of the present model. However, this is not the definitive representation to be estimated, since one must incorporate the coefficient restrictions following from the no-arbitrage pricing conditions (4), (5).…”

“…Then 1 1 + t y is the continuously compounded one period rate between t and t+1. We incorporate it into the model by imposing the requirement A 1 =0 in (6) for j=1. Equivalently, one must have g 1 =LB=C, the first observation equation degenerates to…”

“…It does derive a "shadow" set of asset prices that determine a particular exchange rate value for the hypothetical no forex trade case, in the spirit of Alternative 1. This currency value should obey the standard cross-border asset return parity condition (see Derviz, 2002, for a continuous time model and estimations in the Czech koruna-and the U.S. dollar-euro cases.). However, the model allows for various deviations from the said "Walrasian" outcome, due to heterogeneity of endowments, information or institutional status.…”