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The Cost of Breaking an Exchange Rate Peg:Synthetic Control Estimation

Author

Listed:
  • Jae Hoon Choi

    (Xavier University)

  • A Christopher Limnios

    (Providence College)

Abstract

This paper uses synthetic control estimation to measure the impact of switching exchange rate regimes from fixed to floating on sovereign credit risk. The study confirms the statistically significant short-term cost of breaking a peg. The results demonstrate that breaking the exchange rate peg incurs an increase in the average risk premium by 0.22–0.34 standard deviations for two to five months. The study also investigates peg-formation episodes and finds that switching the regime from floating to fixed and switching the regime from fixed to floating have asymmetric impacts on the country risk spread, and it confirms the hypothesis that investors consider breaking an exchange rate peg as breaking central bank’s commitment to monetary stability.

Suggested Citation

  • Jae Hoon Choi & A Christopher Limnios, 2023. "The Cost of Breaking an Exchange Rate Peg:Synthetic Control Estimation," International Journal of Central Banking, International Journal of Central Banking, vol. 19(3), pages 175-227, August.
    • Handle: RePEc:ijc:ijcjou:y:2023:q:3:a:5
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • F3 - International Economics - - International Finance
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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