Uncovered Interest-rate Parity and Risk Premium: Evidence from EUR/RSD Exchange Rate

This paper examines the uncovered interest-rate parity in a developing economy that implements inflation targeting. We study the exchange rate between the Euro and Serbian Dinar over different time horizons. We apply APARCH-in-mean to measure the impact and nature of a time-varying risk premium and capture the influence of higher-order moments on expected currency returns. We find a significant positive association between the returns and the interest-rate differential over shorter horizons when the risk premium is included. Asymmetries and fat tails are essential in explaining average returns over time horizons of up to one month.