Exchange Rate Volatility and Uncovered Interest Rate Parity in the European Emerging Economies

This paper investigates whether UIRP principle holds and what is predominant driving force, which influences exchange rate movement - economic fundamentals or short-term speculative behaviour. Analysis covers seven East European transition countries and empirical data comprise weekly time series ranging from first week in January 2003 to last week in December 2013. The research method is Component-GARCH in Mean Model, which decomposes temporary and permanent element of volatility. The mean and variance equations have been adjusted for the structural breaks´ presence in order to improve estimated parameters. The results suggested that UIRP principle does not hold in any country. After structural breaks inclusion, we have found that the permanent effect is significant in determination of exchange rate dynamics in five countries, but it does not apply for the transition effect. However, further outliers´ purification revealed that only in Serbia short-term transition component plays an important role.