The puzzling peso

Carlos Arteta (), Steven B. Kamin and Justin Vitanza

Journal of International Money and Finance, 2011, vol. 30, issue 8, 1814-1835

Abstract: In the past decade, some observers have noted an unusual aspect of the Mexican peso’s behavior: During periods when the U.S. dollar has risen (fallen) against other major currencies such as the euro, the peso has risen (fallen) against the dollar. Very few other currencies display this behavior. In this paper, we attempt to explain the unusual pattern of the peso’s correlation with the dollar by developing some general empirical models of exchange rate correlations. Based on a study of 29 currencies, we find that most of the cross-country variation in exchange rate correlations with the dollar and the euro can be explained by just a few variables. First, a country’s currency is more likely to rise against the dollar as the dollar rises against the euro, the closer it is to the United States and the farther it is from the euro area. In this result, distance likely proxies for the role of economic integration in affecting exchange rate correlations. Second, a country’s currency is more likely to exhibit this unusual pattern when its sovereign credit rating is more risky. This may reflect that currencies of riskier countries are less substitutable in investor portfolios than those of better-rated countries. All told, these factors well explain the peso’s unusual behavior, as Mexico both is very close to the United States and has a lower credit rating than most industrial economies.

Keywords: Mexico; Peso; Dollar; Exchange rates; Interest rate differentials; Inflation; Output gap; Output growth differentials (search for similar items in EconPapers)
JEL-codes: E31 E43 F31 (search for similar items in EconPapers)
Date: 2011
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: The puzzling peso (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:30:y:2011:i:8:p:1814-1835

DOI: 10.1016/j.jimonfin.2011.09.002

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