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Exchange rate policy and sovereign bond spreads in developing countries

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  • Samir Jahjah
  • Bin Wei
  • Vivian Zhanwei Yue
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    Abstract

    This paper empirically analyzes how exchange rate policy affects the issuance and pricing of international bonds for developing countries. We find that countries with less flexible exchange rate regimes pay higher sovereign bond spreads and are less likely to issue bonds. Quantitatively, changing a free-floating regime to a fixed regime decreases the likelihood of bond issuance by 4.6% and increases the bond spread by 1.3% on average. Furthermore, countries with real exchange rate overvaluation have higher bond spreads and higher bond issuance probabilities. Moreover, such positive effects of real exchange rate overvaluation tend to be magnified for countries with fixed exchange rate regimes. Our results suggest that choosing a less flexible exchange rate regime in general leads to higher borrowing costs for developing countries, especially when their currencies are overvalued.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 1049.

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    Date of creation: 2012
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    Handle: RePEc:fip:fedgif:1049

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    1. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
    2. Carmen M. Reinhart & Kenneth S. Rogoff, 2014. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 1065-1188, November.
    3. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
    4. Easton, S-T & Rockerbie, D-W, 1996. "What's in a Default? Lending to LDCs in the Face of Default Risk," Discussion Papers dp96-06, Department of Economics, Simon Fraser University.
    5. Sebastian Edwards, 1990. "Real and Monetary Determinants of Real Exchange Rate Behavior: Theory and Evidence From Developing Countries," NBER Working Papers 2721, National Bureau of Economic Research, Inc.
    6. Alberto Alesina & Alexander Wagner, 2003. "Choosing (and reneging on) exchange rate regimes," NBER Working Papers 9809, National Bureau of Economic Research, Inc.
    7. Graciela Kaminsky & Saul Lizondo & Carmen M. Reinhart, 1998. "Leading Indicators of Currency Crises," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 1-48, March.
    8. Cristina Arellano & Jonathan Heathcote, 2007. "Dollarization and financial integration," Staff Report 385, Federal Reserve Bank of Minneapolis.
    9. Carmen M. Reinhart, 2002. "Default, Currency Crises, and Sovereign Credit Ratings," World Bank Economic Review, World Bank Group, vol. 16(2), pages 151-170, August.
    10. Dell'Ariccia, Giovanni & Schnabel, Isabel & Zettelmeyer, Jeromin, 2006. "How Do Official Bailouts Affect the Risk of Investing in Emerging Markets?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(7), pages 1689-1714, October.
    11. Jeffrey A. Frankel & George Saravelos, 2010. "Are Leading Indicators of Financial Crises Useful for Assessing Country Vulnerability? Evidence from the 2008-09 Global Crisis," NBER Working Papers 16047, National Bureau of Economic Research, Inc.
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