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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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  • Sergio L. Schmukler & Luis Serven, 2002. "Pricing Currency Risk: Facts and Puzzles from Currency Boards," NBER Working Papers 9047, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:9047
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    2. Broda, Christian & Yeyati, Eduardo Levy, 2006. "Endogenous Deposit Dollarization," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 963-988, June.
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    5. Neven Valev & John Carlson, 2007. "Beliefs about Exchange‐Rate Stability: Survey Evidence from the Currency Board in Bulgaria," Journal of Economic Policy Reform, Taylor and Francis Journals, vol. 10(2), pages 111-121.
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    7. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk : facts and puzzles from currency boards," Policy Research Working Paper Series 2815, The World Bank.
    8. Alain Raybaut & Dominique Torre, 2004. "Unions monétaires, caisses d'émission et dollarisation: les fondements analytiques des changes "ultra-fixes"," Post-Print hal-00426914, HAL.
    9. Augusto de la Torre & Sergio L. Schmukler, 2007. "Emerging Capital Markets and Globalization : The Latin American Experience," World Bank Publications, The World Bank, number 7187, September.

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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