Working Paper: NBER ID: w9047
Authors: Sergio L. Schmukler; Luis Servén
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.
Keywords: No keywords provided
JEL Codes: F31; F36; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| currency boards (E42) | reduction of currency risk (F31) |
| domestic and global factors (F69) | currency premium (F31) |
| devaluation expectations and risk perceptions (F31) | currency premium (F31) |
| market turbulence (E32) | term structure of currency premium (F31) |
| unexploited arbitrage opportunities or market segmentation (F12) | differences in currency premia (F31) |