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Foreign Exchange Hedging and the Interest Rate Defense

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  • Peter M. Garber
  • Michael G. Spencer

Abstract

In the endgame of a fixed exchange rate regime, increases in interest rates to defend the currency may lead to an apparently perverse market response: further downward pressure on the exchange rate. This may result if a large proportion of investors' foreign exchange exposure is dynamically hedged. This paper describes the trading operations involved in implementing dynamic hedges and the impact of these operations on central bank policy. The success of an interest rate defense hinges on the size and timing of the funding operations of those who are being squeezed relative to those engaged in dynamic hedging.

Suggested Citation

  • Peter M. Garber & Michael G. Spencer, 1995. "Foreign Exchange Hedging and the Interest Rate Defense," IMF Staff Papers, Palgrave Macmillan, vol. 42(3), pages 490-516, September.
    • Handle: RePEc:pal:imfstp:v:42:y:1995:i:3:p:490-516
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    Citations

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    Cited by:

    1. Benjamin Hermalin & Andrew K. Rose & Peter M. Garber & Andrew Crockett & David W. Mullins, Jr, 1999. "Risks to Lenders and Borrowers in International Capital Markets," NBER Chapters, in: International Capital Flows, pages 363-420, National Bureau of Economic Research, Inc.
    2. Malz, Allan M., 1996. "Using option prices to estimate realignment probabilities in the European Monetary System: the case of sterling-mark," Journal of International Money and Finance, Elsevier, vol. 15(5), pages 717-748, October.
    3. Krueger, Malte, 1999. "Dynamic hedging in currency crisis," Economics Letters, Elsevier, vol. 62(3), pages 347-350, March.
    4. Kyung-Soo Kim, 2006. "An Optimal Commitment Model of Exchange Rate Stabilization," Korean Economic Review, Korean Economic Association, vol. 22, pages 249-265.
    5. Ngee-Choon Chia, 1998. "Motor Vehicle Taxes as Environmental Instruments: The Case of Singapore," University of Western Ontario, Departmental Research Report Series 9811, University of Western Ontario, Department of Economics.
    6. Árvai, Zsófia & Vincze, János, 1998. "Valuták sebezhetősége pénzügyi válságok a kilencvenes években [Vulnerability of currencies financial crises in the nineties]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(6), pages 509-533.
    7. Piersanti, Giovanni, 2012. "The Macroeconomic Theory of Exchange Rate Crises," OUP Catalogue, Oxford University Press, number 9780199653126.
    8. Woosik Moon & Yeongseop Rhee, 2006. "Spot and foward market intervention during the 1997 Korean currency crisis," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 59(238), pages 243-268.
    9. Giancarlo Marini & Giovanni Piersanti, 2012. "Models of Speculative Attacks and Crashes in International Capital Markets," CEIS Research Paper 245, Tor Vergata University, CEIS, revised 24 Jul 2012.
    10. Maria Aguirre & Reza Saidi, 2000. "Volatility behavior of exchange rate future contracts," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 28(4), pages 396-411, December.
    11. Woosik Moon & Yeongseop Rhee, 2006. "Spot and foward market intervention during the 1997 Korean currency crisis," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 59(238), pages 243-268.
    12. Drazen, Allan, 2000. "Interest-rate and borrowing defense against speculative attack," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 303-348, December.

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