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Pricing Currency Risk: Facts and Puzzles from Currency Boards

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  • Sergio L. Schmukler
  • Luis Serven

Abstract

Hard pegs, such as currency boards, intend to reduce or even eliminate currency risk. This paper investigates the patterns and determinants of the currency risk premium in two currency boards -- Argentina and Hong Kong. Despite the presumed rigidity of currency boards, the currency premium is almost always positive and at times very large. Its term structure is usually upward sloping, but flattens out or even becomes inverted at times of turbulence. Currency premia differ across markets. The forward discount typically exceeds the currency premium derived from interbank rates, particularly during crisis times. The large magnitude of these cross-market differences can be the consequence of unexploited arbitrage opportunities, market segmentation, or other risks embedded in typical measures of currency risk. The premium and its term structure depend on domestic and global factors, related to devaluation expectations and risk perceptions.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9047.

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Date of creation: Jul 2002
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Publication status: published as Schmukler, Sergio L. and Luis Serven. "Pricing Currency Risk Under Currency Boards," Journal of Development Economics, 2002, v69(2,Dec), 367-391.
Handle: RePEc:nbr:nberwo:9047

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Cited by:
  1. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk : facts and puzzles from currency boards," Policy Research Working Paper Series 2815, The World Bank.
  2. Neven Valev & John A. Carlson, 2002. "Tenuous Financial Stability," International Center for Public Policy Working Paper Series, at AYSPS, GSU, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University paper0210, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
  3. Broda, Christian & Yeyati, Eduardo Levy, 2006. "Endogenous Deposit Dollarization," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 38(4), pages 963-988, June.
  4. Neven T. Valev & John A. Carlson, 2007. "Beliefs about Exchange-Rate Stability: Survey Evidence from the Currency Board in Bulgaria," Journal of Economic Policy Reform, Taylor and Francis Journals, Taylor and Francis Journals, vol. 10(2), pages 111-121.
  5. Neven Valev, 2000. "Building Monetary Credibility in a Transforming Economy," International Center for Public Policy Working Paper Series, at AYSPS, GSU, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University paper0212, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.

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