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Should Government Smooth Exchange Rate Risk?

Author

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  • Ilan Goldfajn
  • Marcos Antonio Silveira

Abstract

A general equilibrium model is built to explain if there are circumstances in which exchange rate risk smoothing (ERRS) policies may bring a Pareto-improvement for an indebted small open (home) economy. The model shows that this is the case when overpessimistic foreign creditors demand a large spread on the default risk-free world interest rate, whose size can be reduced by ERRS policies and, in addition, market imperfections, such as information asymmetry between foreign investors and domestic debtors, prevent home economy's residents from internalizing all benefits and costs of the exchange rate risk reallocation into their allocative decisions.

Suggested Citation

  • Ilan Goldfajn & Marcos Antonio Silveira, 2002. "Should Government Smooth Exchange Rate Risk?," Working Papers Series 48, Central Bank of Brazil, Research Department.
    • Handle: RePEc:bcb:wpaper:48
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    File URL: https://www.bcb.gov.br/content/publicacoes/WorkingPaperSeries/wps48.pdf
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    References listed on IDEAS

    as
    1. Goldfajn, Ilan, 2000. "Public Debt Indexation and Denomination: The Case of Brazil," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 5(1), pages 43-56, February.
    2. Sushil Bikhchandani & Sunil Sharma, 2001. "Herd Behavior in Financial Markets," IMF Staff Papers, Palgrave Macmillan, vol. 47(3), pages 1-1.
    3. Backus, David K. & Kehoe, Patrick J., 1989. "On the denomination of government debt : A critique of the portfolio balance approach," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 359-376, May.
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    6. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 329-368.
    7. repec:bla:econom:v:50:y:1983:i:199:p:291-300 is not listed on IDEAS
    8. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2001. "Hedging and financial fragility in fixed exchange rate regimes," European Economic Review, Elsevier, vol. 45(7), pages 1151-1193.
    9. Miller, Victoria, 1997. "Why a government might want to consider foreign currency denominated debt," Economics Letters, Elsevier, vol. 55(2), pages 247-250, August.
    10. Calvo, Guillermo A. & Mendoza, Enrique G., 1996. "Mexico's balance-of-payments crisis: a chronicle of a death foretold," Journal of International Economics, Elsevier, vol. 41(3-4), pages 235-264, November.
    11. Bohn, Henning, 1990. "Tax Smoothing with Financial Instruments," American Economic Review, American Economic Association, vol. 80(5), pages 1217-1230, December.
    12. Alessandro Missale, 1997. "Managing the Public Debt: The Optimal Taxation Approach," Journal of Economic Surveys, Wiley Blackwell, vol. 11(3), pages 235-265, September.
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    14. Enrique G. Mendoza & Guillermo A. Calvo, 2000. "Capital-Markets Crises and Economic Collapse in Emerging Markets: An Informational-Frictions Approach," American Economic Review, American Economic Association, vol. 90(2), pages 59-64, May.
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    Cited by:

    1. Marcelo de Paiva Abreu, 2003. "The political economy of economic integration in the Americas: Latin American interests," Textos para discussão 468, Department of Economics PUC-Rio (Brazil).
    2. Edwards, Sebastian, 2002. "The great exchange rate debate after Argentina," The North American Journal of Economics and Finance, Elsevier, vol. 13(3), pages 237-252, December.
    3. repec:onb:oenbwp:y::i:74:b:1 is not listed on IDEAS

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