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Pricing Currency Risk under Currency Boards. Published in Journal of Development Economics (2002).

Title:

Pricing Currency Risk under Currency Boards. Published in Journal of Development Economics (2002).

Authors:
[alphabetically]

Sergio Schmukler, and Luis Serven

Pub. Date:

December 1, 2002

Full Text:

Adobe Acrobat (PDF) [213 KB]

Currency risk is one of the two components of the total interest rate differential. Hard pegs, such as currency boards, are meant to reduce or even eliminate currency risk, thus reducing domestic interest rates. This paper investigates the patterns and determinants of the currency risk premium in two currency boards – Argentina and Hong Kong. Despite the presumed rigidity of currency boards, the currency premium is almost always positive and at times very large. Its term structure is usually upward sloping, but flattens out or even becomes inverted at times of turbulence. The premium and its term structure depend on domestic and global factors, related to devaluation expectations and risk perceptions.




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