Working Paper: NBER ID: w15401
Authors: Kris James Mitchener; Marc D. Weidenmier
Abstract: We test whether fixed exchange rate regimes are ever credible in emerging markets by analyzing the behavior of short-term domestic trade bills across countries during the classical gold standard period, the most widely used hard peg in modern financial history. We exploit the fact that global capital markets were unfettered in order to identify the currency-risk component using uncovered interest parity for 17 of the largest emerging market borrowers for the period 1870-1913. We show that five years after a country joined the gold standard, the currency risk premium averaged at least 285 basis points for emerging market economies. We estimate that investors expected exchange rates to fall by roughly 28 percent even after emerging market borrowers joined the gold standard. Positive currency risk premiums that persisted long after gold standard adoption suggests that hard pegs for emerging market borrowers may never be fully credible.
Keywords: fixed exchange rates; emerging markets; gold standard; currency risk
JEL Codes: F2; 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 |
|---|---|
| joining the gold standard (F33) | currency risk premium (F31) |
| currency risk premium (F31) | belief in credibility of hard pegs (F33) |
| interest rate differentials (E43) | perceived credibility of hard pegs (F31) |
| perceived risk of devaluation (F31) | market perceptions regarding stability of hard pegs (F31) |
| joining the gold standard (F33) | investors expecting exchange rates to fall (F31) |