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

49 Pages Posted: 7 Feb 2017 Last revised: 13 Jan 2020

See all articles by Wenxin Du

Wenxin Du

University of Chicago Booth School of Business

Carolin E. Pflueger

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

Jesse Schreger

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

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Date Written: January 10, 2020

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 Pflueger, Carolin E. and Schreger, Jesse, Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy (January 10, 2020). 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 )

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Carolin E. Pflueger (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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University of Chicago - Harris School of Public Policy ( email )

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Jesse Schreger

Columbia University - Columbia Business School, Economics ( email )

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United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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