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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. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 865-90, October.
  2. Tesar, Linda L., 1995. "Evaluating the gains from international risksharing," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 42(1), pages 95-143, June.
  3. Torsten Persson & Lars E.O. Svensson, 1989. "Exchange Rate Variability And Asset Trade," NBER Working Papers 2811, National Bureau of Economic Research, Inc.
  4. 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.
  5. Barry Eichengreen and Tamim Bayoumi., 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 (CIDER) Working Papers C96-081, University of California at Berkeley.
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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 4385, C.E.P.R. Discussion Papers.
  2. Lahiri, Amartya & Singh, Rajesh & Vegh, Carlos, 2007. "Segmented asset markets and optimal exchange rate regimes," Journal of International Economics, Elsevier, vol. 72(1), pages 1-21, May.

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