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Optimal bond holding dynamics with hedging against real exchange rate risks

Author

Listed:
  • Kim, Kyounghun
  • Kim, Sunghyun
  • Lim, Sanho

Abstract

This study examines optimal bond holding dynamics using a two-country DSGE model with two bonds. Unlike previous studies focusing on steady-state properties of optimal bond holdings, we solve the model by employing a third-order approximation method and show how optimal bond holdings respond when macro fundamentals change. In particular, we derive impulse responses of optimal home and foreign bond holdings to productivity shocks. Simulation results show that with a positive productivity shock at home, optimizing home agents decrease holdings of home bonds and increase holdings of foreign bonds. Correlation between relative price and excess bond returns following a positive productivity shock makes home (foreign) bond a less (more) attractive hedging tool against real exchange rate risks. In addition, we use a SVAR method and verify that the optimal bond holding dynamics derived from the model are observed in the data.

Suggested Citation

  • Kim, Kyounghun & Kim, Sunghyun & Lim, Sanho, 2023. "Optimal bond holding dynamics with hedging against real exchange rate risks," International Review of Economics & Finance, Elsevier, vol. 86(C), pages 626-638.
    • Handle: RePEc:eee:reveco:v:86:y:2023:i:c:p:626-638
    DOI: 10.1016/j.iref.2023.03.044
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    More about this item

    Keywords

    Hedge ratio; Real exchange rate risk; DSGE model; Higher order approximation; SVAR;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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