Testing the UIP theory in the CEE countries: evidence from the GARCH models

This paper tests the Uncovered Interest Parity theorem at the level of the CEE countries using three types of GARCH models (EGARCH, TGARCH and CGARCH models). In general the empirical results highlight that UIP is not confirmed. We find that a possible explanation for this might consist of an indiscriminate risk premium that results in a violation of the underlying assumptions of UIP. The analysis brings in a series of risk premiums which reflect the build up of various risk layers encompassed in the dynamics of macro-economic fundamentals and macro-financial variables. Apart from revealing those risk layers which trigger macroeconomic volatility, the research sheds light on the countries’ limited capacity to achieve nominal and real convergence in the not too distant future.