Uncertain Exchange Rate Policies and Interest Rate Determination
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Uncertain Exchange Rate Policies and Interest Rate Determination
Andersen, Torben M. | Sørensen, Jan Rose
Credit and Capital Markets – Kredit und Kapital, Vol. 24 (1991), Iss. 4 : pp. 468–483
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Torben M. Andersen, Aarhus
Jan Rose Sørensen, Aarhus
References
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Giovannini, A. and Weil, A. (1989): Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Market, NBER Working Paper 2824.
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Horn, H. and Persson, T. (1988): Exchange Rate Policy, Wage Formation and Credibility, European Economic Review, 32, 1621 - 1636.
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Marston, R. C. (1985): Stabilization Policies in Open Economies, in Jones, R. W. and Kenen, P. B. (eds.): Handbook of International Economics, Vol. II, North Holland.
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Siegel, J. J. (1972): Risk, Interest Rates, and the Forward Exchange, Quarterly Journal of Economics, 303 - 309.
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Andersen, T. M. and Risager, O. (1988): Stabilization Policies, Credibility and Interest Rate Determination in a Small Open Economy, European Economic Review, 32, 669 – 679.
Google Scholar -
Andersen, T. M. and Risager, O. (1991): The Role of Credibility for the Effects of a Change in the Exchange Rate Policy, Oxford Economic Papers, 43, 85 – 98.
Google Scholar -
Andersen, T. M. and Sorensen, J. R. (1990): Interest Rate Spreads and Exchange Rate Variability, Mimeo, Centre for International Economics, Institute of Economics, University of Aarhus.
Google Scholar -
Christensen, M. (1988): Policy Credibility and the Lucas Critique – Some New Tests with an Application to Denmark, in Artus, P. et al. (eds.): Monetary and Financial Models (Nijhoff, to appear). -- Fama, E. F. and Farber, A. (1979): Money, Bonds and Foreign Exchange, American Economic Review, 69, 639 -649.
Google Scholar -
Giovannini, A. and Jorion, P. (1988): The Time-Variation of Risk and Return in the Foreign Exchange and Stock Market, NBER Working Paper 2573.
Google Scholar -
Giovannini, A. and Weil, A. (1989): Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Market, NBER Working Paper 2824.
Google Scholar -
Horn, H. and Persson, T. (1988): Exchange Rate Policy, Wage Formation and Credibility, European Economic Review, 32, 1621 – 1636.
Google Scholar -
Marston, R. C. (1985): Stabilization Policies in Open Economies, in Jones, R. W. and Kenen, P. B. (eds.): Handbook of International Economics, Vol. II, North Holland.
Google Scholar -
Siegel, J. J. (1972): Risk, Interest Rates, and the Forward Exchange, Quarterly Journal of Economics, 303 – 309.
Google Scholar
Abstract
Uncertain Exchange Rate Policies and Interest Rate Determination
We analyse how an uncertain exchange rate policy affects interest rate differences between countries participating in a managed exchange rate system. It is shown that the interest rate of asmall and open economy always has a positive risk premium relative to the interest rate of a big and open economy. The paper explores the complex deviation from the uncovered interest rate parity condition implied by positive risk premia. Specifically, it turns out that the interest rate is increasing in the potential size of a devaluation, but a higher probability of a depreciation does not necessarily increase the interest rate, since expectations and variances may be affected in different directions