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Exchange Rate Proclamations and Sovereign Risk Premiums

Exchange Rate Proclamations and Sovereign Risk Premiums. Alexandra Guisinger University of Notre Dame David Andrew Singer MIT. IPES, Nov. 13, 2009. Motivation: De Jure Policy Matters.

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Exchange Rate Proclamations and Sovereign Risk Premiums

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  1. Exchange Rate Proclamations and Sovereign Risk Premiums Alexandra Guisinger University of Notre Dame David Andrew Singer MIT IPES, Nov. 13, 2009

  2. Motivation: De Jure Policy Matters • If governments choose economic policies that deviate from their public commitments, are those commitments meaningless? • Our empirical focus: de facto vs. de jure exchange rate regimes • Evidence of “fear of floating,” new data on de facto policy • New pattern in IPE scholarship: ignore de jure policy • Argument: de jure policy matters for… • Inflation (Guisinger & Singer, IO, 2010) • Sovereign borrowing costs

  3. Developing Country Sample Classification (by Percentage), 1994-2005

  4. De jure exchange rate policy and sovereign borrowing costs • Existing literature privileges de facto fixing • Countries adopt “fear of floating” to reduce risk, ease access to foreign capital (Calvo & Reinhart; Alesina & Wagner) • These conjectures have not been rigorously tested! • Our counter argument: de jure policy is an important signal to markets • Markets reward countries for sticking with their commitments • De facto policy inconsistent with official policy causes market confusion

  5. Two Empirical Tests of the Impact of De Jure/De Facto Consistency • First test: does DJ/DF consistency affect country selection into JP Morgan’s EMBIG index? • Inclusion represents validation by institutional investors and countries’ ability to float bonds • By 2005, EMBIG covered 33 countries • Second test: does DJ/DF consistency lower sovereign bond spreads?

  6. First test: Inclusion in EMBIG • Sample: 99 developing countries, 1994-2005 • DV: 1 if included, 0 otherwise • Note: countries can fall out of the index • Explanatory variables: • De jure fix (0/1) – coded from IMF data • De facto fix (0/1) – coded from Reinhart & Rogoff • Interaction: De jure & de facto fix • Alternative variable: “consistency” (0/1) • Controls: • Democracy; political crisis; GDP/c; inflation; external debt; history of rescheduling; year dummies • Model: logit, errors clustered on country

  7. Partial Regression results: EMBIG Inclusion Residuals Contingent Upon DJ-DF Consistency Consistent Inconsistent

  8. Analysis of Country Characteristics on EMBIG Availability (1994-2005)

  9. Second Test: Sovereign Spreads • Sample: 32 countries, 1994-2005 • DV: EMBIG spread (logged) • Explanatory variables: • De jure fix (0/1) • De facto fix (0/1) • Interaction: De jure & de facto fix • Alternative variable: “consistency” (0/1) • Controls: • Democracy; political crisis; GDP/c; inflation; external debt; history of rescheduling; year dummies • Model: OLS, random effects w/AR1; fixed effects

  10. Sovereign Spreads by Exchange Rate Combinations, 1994-2005

  11. Partial Regression results: EMBIG Spreads Residuals Contingent Upon DJ-DF Consistency Consistent Inconsistent

  12. Analysis of Country Characteristics on EMBIG Spreads (1994-2005)

  13. Conclusion • Consistency between de facto and de jure matters for borrowing costs • Need alternative explanation for “fear of floating” • Policy implication: governments that adopt ‘fear of floating’ pay a price • Research implication: do not dismiss de jure policy • Use de facto measures only after careful consideration • De jure policy represents policy; de facto is implementation

  14. Analysis of Country Characteristics on EMBIG Spreads (1994-2005)

  15. EMBIG Country Coverage • Argentina (1994- ) • China (1994- ) • Korea, Rep. (1994-2004 ) • Nigeria (1994- ) • Venezuela, RB (1994-) • Brazil (1995- ) • Bulgaria (1995- ) • Ecuador (1995- ) • Poland (1995- ) • South Africa (1995- ) • Colombia (1995- ) • Croatia (1997-2004) • Malaysia (1997- ) • Panama (1997- ) • Peru (1997- ) • Turkey (1997- ) • Mexico (1998- ) • Morocco (1998- 2006) • Philippines (1998- ) • Russian Federation (1998- ) • Thailand (1998-2006 ) • Algeria (1999-2003 ) • Costa Rica (1999- ) • Hungary (1999- ) • Lebanon (1999- ) • Chile (2000- ) • Ukraine (2001- ) • Dominican Republic (2002- ) • Egypt, Arab Rep. (2002- ) • Pakistan (2002- ) • Uruguay (2002- ) • El Salvador (2003- ) • Tunisia (2003- ) • Indonesia (2003- )

  16. Distribution of Raw and Logged Spreads

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