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Risk Sharing and the Theory of Optimal Currency Areas: A Re-examination of Mundell 1973

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  • Stephen Ching

    (City University of Hong Kong)

  • Michael B. Devereux

    (University of British Columbia)

Abstract

Mundell (1973) argues that a common currency area provides benefits for its members by offering insurance against region-specific shocks. We develop a simple model to analyse the nature of risksharing benefits of a single currency area for emerging market economies, based on Mundell's hypothesis. An important pre-requisite for the risk-sharing benefits of a single currency is that there be limited trade among countries in national-currency denominated bonds. The evidence for emerging markets supports this assumption. In this case, we show that a single currency area may support risk sharing that could not be achieved under floating exchange rates. Based on a simple quantitative evaluation of our model, we show that the implied risk sharing can be substantial.

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Bibliographic Info

Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 082000.

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Length: 15 pages
Date of creation: Nov 2000
Date of revision:
Handle: RePEc:hkm:wpaper:082000

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  1. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
  2. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Scholarly Articles 3445091, Harvard University Department of Economics.
  3. Tesar, Linda L., 1995. "Evaluating the gains from international risksharing," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 42(1), pages 95-143, June.
  4. Eichengreen, Barry & Bayoumi, Tamim, 1996. "Is Asia an Optimum Currency Area? Can It Become One? Regional, Global and Historical Perspectives on Asian Monetary Relations," Center for International and Development Economics Research, Working Paper Series, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkele qt1td5x343, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  5. Persson, Torsten & Svensson, Lars E. O., 1989. "Exchange rate variability and asset trade," Journal of Monetary Economics, Elsevier, Elsevier, vol. 23(3), pages 485-509, May.
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Cited by:
  1. Celentani, Marco & Conde-Ruiz, José Ignacio & Desmet, Klaus, 2004. "Inflation in Open Economies with Complete Markets," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4385, C.E.P.R. Discussion Papers.
  2. Marco Celentani & J. Ignacio Conde-Ruiz & Klaus Desmet, . "Inflation in open economies with complete markets," Working Papers 2004-12, FEDEA.
  3. Amartya Lahiri & Rajesh Singh & Carlos A. Vegh, 2007. "Segmented Asset Markets and Optimal Exchange Rate Regimes," NBER Working Papers 13154, National Bureau of Economic Research, Inc.

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