Pricing Currency Risk Under Currency Boards

Posted: 19 Feb 2003

See all articles by Sergio L. Schmukler

Sergio L. Schmukler

World Bank - Development Research Group (DECRG)

Luis Servén

World Bank - Development Research Group (DECRG)

Abstract

Currency risk is one of the two components of the total interest rate differential. Hard pegs, such as currency boards, are meant to reduce or even eliminate currency risk, thus, reducing domestic interest rates. 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. The premium and its term structure depend on domestic and global factors related to devaluation expectations and risk perceptions.

Keywords: Currency risk, Currency premium, Forward discount, Currency board, Term structure, Covered interest parity, Market segmentation, Financial crises

JEL Classification: F31, F36, G12, G15

Suggested Citation

Schmukler, Sergio and Servén, Luis, Pricing Currency Risk Under Currency Boards. Journal of Development Economics, Vol. 69, No. 2. Available at SSRN: https://ssrn.com/abstract=362680

Sergio Schmukler (Contact Author)

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

1818 H. Street, N.W.
MSN MC 3-301
Washington, DC 20433
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202-458-4167 (Phone)
202-522-3518 (Fax)

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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