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Should Government Smooth Exchange Rate Risk?

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  • Ilan Goldfajn
  • Marcos Antonio Silveira
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    Abstract

    A general equilibrium model is built to explain if there are circumstances in which exchange rate risk smoothing (ERRS) policies may bring a Pareto-improvement for an indebted small open (home) economy. The model shows that this is the case when overpessimistic foreign creditors demand a large spread on the default risk-free world interest rate, whose size can be reduced by ERRS policies and, in addition, market imperfections, such as information asymmetry between foreign investors and domestic debtors, prevent home economy's residents from internalizing all benefits and costs of the exchange rate risk reallocation into their allocative decisions.

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    File URL: http://www.bcb.gov.br/pec/wps/ingl/wps48.pdf
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    Bibliographic Info

    Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 48.

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    Date of creation: Sep 2002
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    Publication status: Published in Journal of Development Economics, Vol. 69, no. 2 (Dec 2002): 393-421.
    Handle: RePEc:bcb:wpaper:48

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    Web page: http://www.bcb.gov.br/?english

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    1. Miller, Victoria, 1997. "Why a government might want to consider foreign currency denominated debt," Economics Letters, Elsevier, vol. 55(2), pages 247-250, August.
    2. Missale, Alessandro, 1997. " Managing the Public Debt: The Optimal Taxation Approach," Journal of Economic Surveys, Wiley Blackwell, vol. 11(3), pages 235-65, September.
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    Cited by:
    1. Edwards, Sebastian, 2002. "The great exchange rate debate after Argentina," The North American Journal of Economics and Finance, Elsevier, vol. 13(3), pages 237-252, December.

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