Uncovered Interest Parity and Expected Depreciation in a Dollarized Cambodian Economy

Abstract

This paper tests the Uncovered Interest Parity (UIP) for Cambodian economy using the Generalized Methods of Moment (GMM). GMM method is used to address the weak result of simple OLS method, including the problems of endoneneity, serial correlation, heteroskedasticity. The result showed that, during the period of exchange rate stability, UIP is not valid even the country is a very highly dollarized economy and people can save in both local currency and USD in domestic banks. The UIP coefficient is negative and significant for three-month and six-month interest rates. The negative coefficient suggests that the monetary policy that tries to decrease interest rate (increase) may face the risk of currency depreciation (appreciation). If local currency depreciation is the driving force of dollarization, reducing local interest rate will encourage more dollarization in the economy.