Pricing Currency Risk: Facts and Puzzles from Currency Boards

72 Pages Posted: 11 Jul 2002 Last revised: 28 Oct 2010

See all articles by Sergio L. Schmukler

Sergio L. Schmukler

World Bank - Development Research Group (DECRG)

Luis Servén

World Bank - Development Research Group (DECRG)

Multiple version iconThere are 2 versions of this paper

Date Written: July 2002

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.

Suggested Citation

Schmukler, Sergio and Servén, Luis, Pricing Currency Risk: Facts and Puzzles from Currency Boards (July 2002). NBER Working Paper No. w9047. Available at SSRN: https://ssrn.com/abstract=318842

Sergio Schmukler (Contact Author)

World Bank - Development Research Group (DECRG) ( email )

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HOME PAGE: http://www.worldbank.org/en/about/people/s/sergio-schmukler

Luis Servén

World Bank - Development Research Group (DECRG)

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

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