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The Credibility of Cabo Verde’s Currency Peg

  • Macedo, Jorge Braga de
  • Pereira, Luis Brites

This paper studies the credibility of the currency peg of Cape Verde (CV) by assessing the impact of economic fundamentals, our explanatory variables, on the stochastic properties of Exchange Market Pressure (EMP), the dependent variable, using EGARCH-M models. Our EMP descriptive analysis finds a substantial reduction in the number of crisis episodes and of (unconditional) volatility after the peg’s adoption. Moreover, our estimation results suggest that mean EMP is driven by fundamentals and that conditional variability is more sensitive to negative shocks. We also find evidence that the expected return from holding CV’s assets is lower under the currency peg for the same increase in monthly volatility. The reason is that the return’s composition is “more virtuous”, as it results from the strengthening of CV’s foreign reserve position and is not due to either a larger risk premium or favourable exchange rate movements. We take this to be a sign of the credibility of the peg, which apparently reflects the intertemporal credibility of CV’s economic policy and so has successfully withstood international markets’ scrutiny.

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File URL: http://fesrvsd.fe.unl.pt/WPFEUNL/WP2006/wp494.pdf
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Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp494.

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Length: 32 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:unl:unlfep:wp494
Contact details of provider: Postal: Campus de Campolide, 1099-032 Lisboa
Phone: (351) 21 3801638
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Web page: http://www.fe.unl.pt
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  1. M. Ayhan Kose & Eswar Prasad & Kenneth S. Rogoff & Shang-Jin Wei, 2006. "Financial Globalization: A Reappraisal," NBER Working Papers 12484, National Bureau of Economic Research, Inc.
  2. Linda S. Goldberg & Michael W. Klein, 2007. "Establishing Credibility: Evolving Perceptions of the European Central Bank," The Institute for International Integration Studies Discussion Paper Series iiisdp194, IIIS.
  3. Pentti J.K. Kouri & Jorge B. de Macedo, 1978. "Exchange Rates and the International Adjustment Process," Cowles Foundation Discussion Papers 488, Cowles Foundation for Research in Economics, Yale University.
  4. Fukuta, Yuichi & Saito, Makoto, 2002. "Forward Discount Puzzle and Liquidity Effects: Some Evidence from Exchange Rates among the United States, Canada, and Japan," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(4), pages 1014-33, November.
  5. Girton, Lance & Roper, Don, 1977. "A Monetary Model of Exchange Market Pressure Applied to the Postwar Canadian Experience," American Economic Review, American Economic Association, vol. 67(4), pages 537-48, September.
  6. Pentti J. K. Kouri & Jorge Braga De Macedo, 1978. "Exchange Rates and the International Adjustments Process," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 9(1), pages 111-158.
  7. Romain Weber, 2005. "Cape Verde's exchange rate policy and its alternatives," BCL working papers 16, Central Bank of Luxembourg.
  8. Weymark, Diana N., 1995. "Estimating exchange market pressure and the degree of exchange market intervention for Canada," Journal of International Economics, Elsevier, vol. 39(3-4), pages 273-295, November.
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