Optimal Bond Holding Dynamics with Hedging Motives Against Real Exchange Rate Risks

28 Pages Posted: 28 Jun 2022

See all articles by Kyounghun Kim

Kyounghun Kim

Korea chamber of commerce & industry

Sanho Lim

Sungkyunkwan University

Sunghyun Henry Kim

Sungkyunkwan University - Department of Economics

Abstract

This study examines optimal bond holding dynamics using a two-country DSGE model with two bonds. Unlike previous studies focusing on steady-state properties of optimal bond holdings, we solve the model by employing a third-order approximation method and show how optimal bond holdings respond when macro fundamentals change. In particular, we derive impulse responses of optimal home and foreign bond holdings to productivity shocks. Simulation results show that with a positive productivity shock at home, optimizing home agents decrease holdings of home bonds and increase holdings of foreign bonds. Correlation between relative price and excess bond returns following a positive productivity shock makes home (foreign) bond a less (more) attractive hedging tool against real exchange rate risks. In addition, we use a SVAR method and verify that the optimal bond holding dynamics derived from the model are observed in the data.

Keywords: Hedge ratio, real exchange rate risk, DSGE model, higher order approximation, SVAR

Suggested Citation

Kim, Kyounghun and Lim, Sanho and Kim, Sunghyun Henry, Optimal Bond Holding Dynamics with Hedging Motives Against Real Exchange Rate Risks. Available at SSRN: https://ssrn.com/abstract=4148616 or http://dx.doi.org/10.2139/ssrn.4148616

Kyounghun Kim

Korea chamber of commerce & industry ( email )

39 Sejong-daero, Sogong-dong
Jung-gu, Seoul
Korea, Republic of (South Korea)

Sanho Lim

Sungkyunkwan University ( email )

53 Myeongnyun-dong 3-ga Jongno-ju
Guro-gu
Seoul, 110-745
Korea, Republic of (South Korea)

Sunghyun Henry Kim (Contact Author)

Sungkyunkwan University - Department of Economics ( email )

110-745 Seoul
Korea

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