The present study investigates whether liquidity premia can explain deviationsfrom uncovered interest parity. For that purpose I modify a representativeagent asset-pricing model by assuming that investors value liquidity serviceswhich are unique features of U.S. Treasuries. Further the assumption thatdomestic and foreign bonds are perfect substitutes is relaxed. Estimation results for U.S. and U.K. data provide support for the hypothesis that investors valuation for U.S. Treasuries liquidity contributes to explain deviations fromuncovered interest parity. In contrast to most forward premium regression estimations, I find a positive association between the expected depreciation rateof the U.S. currency relative to the UK currency and the U.S.-U.K. Treasuryyield spread.
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