Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy

45 Pages Posted: 7 Feb 2017 Last revised: 21 Aug 2019

See all articles by Wenxin Du

Wenxin Du

University of Chicago Booth School of Business

Carolin E. Pflueger

University of Chicago - Harris Public Policy; National Bureau of Economic Research (NBER)

Jesse Schreger

Columbia University - Columbia Business School; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: August 20, 2019

Abstract

We document that governments whose local currency debt provides them with greater hedging benefits actually borrow more in foreign currency. We introduce two features into a government's debt portfolio choice problem to explain this finding: risk-averse lenders and lack of monetary policy commitment. A government without commitment chooses excessively counter-cyclical inflation ex post, which leads risk-averse lenders to require a risk premium ex ante. This makes local currency debt too expensive from the government's perspective and thereby discourages the government from borrowing in its own currency.

Keywords: local currency debt, bond betas, inflation cyclicality, bond risk premia, inflation commitment

JEL Classification: G12, G15, E3

Suggested Citation

Du, Wenxin and Pflueger, Carolin E. and Schreger, Jesse, Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy (August 20, 2019). Available at SSRN: https://ssrn.com/abstract=2912513 or http://dx.doi.org/10.2139/ssrn.2912513

Wenxin Du

University of Chicago Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://https://sites.google.com/site/wenxindu/

Carolin E. Pflueger (Contact Author)

University of Chicago - Harris Public Policy ( email )

1155 East 60th Street
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jesse Schreger

Columbia University - Columbia Business School

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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