This study empirically examines the effect of foreign exchange (FX) market liquidity risk and volatility on the excess … returns of currency carry trades. In contrast to the existent literature, we construct an alternative proxy of liquidity risk … evidence that uncovered interest parity (UIP) puzzle can be resolved after controlling for liquidity risk and market volatility …

daily option panel of 15 currencies. This analysis reveals that (i) put risk premiums are negative, implying across …-the-board interest in hedging foreign currency depreciations; (ii) call risk premiums are of variable sign and not as pronounced as for … puts; (iii) volatility risk premiums are small or insignificant; and (iv) put (call) risk premiums are more (less) negative …