Computing and Testing a Stable Common Currency for Mercosur Countries
Journal of Applied Economics, Vol. 11, No. 1, pp. 193-220, May 2008
Posted: 17 Feb 2011 Last revised: 20 Nov 2012
Date Written: May 2008
This paper develops a stable common currency for mid-sized open monetary economies with incomplete markets in general and the Mercosur countries in particular. The proposed currency is constructed as a derivative of a dynamic portfolio of securities that proxies the nominal exchange risk factors for a set of monies and floats against the rest of the world's currencies. We find that the resulting optimal common currency is comprised of currencies with country weights that are statistically significant and fairly symmetrical with relatively equal weight (e.g., 22% Argentinean pesos, 27% Brazilian reals, 27% Chilean pesos, and 23% Uruguayan pesos). We also find that increasing the number of countries in a common currency tends to increase its stability. The willingness of Mercosur countries to participate in a monetary union is assessed from statistical moments of the density functions of the implied stable common currency and its components.
Keywords: stable common currency, open monetary economies, regime switching models, Mercosur, currency basket
JEL Classification: F15, F33
Suggested Citation: Suggested Citation