Working Paper: CEPR ID: DP10388
Authors: Kris Mitchener; Marc Weidenmier
Abstract: We use a standard metric from international finance, the currency risk premium, to assess the credibility of fixed exchange rates during the classical gold standard era. Theory suggests that a completely credible and permanent commitment to join the gold standard would have zero currency risk or no expectation of devaluation. We find that, even five years after a typical emerging-market country joined the gold standard, the currency risk premium averaged at least 220 basis points. Fixed- effects, panel-regression estimates that control for a variety of borrower-specific factors also show large and positive currency risk premia. In contrast to core gold standard countries, such as France and Germany, the persistence of large premia, long after gold standard adoption, suggest that financial markets did not view the pegs in emerging markets as credible and expected devaluation.
Keywords: currency risk; fixed exchange rates; gold standard; sovereign borrowing
JEL Codes: F22; F33; F36; F41; N10; N20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| currency risk premium (F31) | financial markets' skepticism regarding credibility of exchange rate pegs (F31) |
| core countries (O57) | lack of significant currency risk premiums (G15) |
| gold standard adoption (E42) | currency risk premium (F31) |
| gold standard adoption (E42) | expectation of devaluation (F31) |
| emerging markets (O53) | persistence of significant currency risk premiums (F31) |