The Cost of Breaking an Exchange Rate Peg:Synthetic Control Estimation

Jae Hoon Choi and A Christopher Limnios
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Jae Hoon Choi: Xavier University
A Christopher Limnios: Providence College

International Journal of Central Banking, 2023, vol. 19, issue 3, 175-227

Abstract: This paper uses synthetic control estimation to measure the impact of switching exchange rate regimes from fixed to floating on sovereign credit risk. The study confirms the statistically significant short-term cost of breaking a peg. The results demonstrate that breaking the exchange rate peg incurs an increase in the average risk premium by 0.22–0.34 standard deviations for two to five months. The study also investigates peg-formation episodes and finds that switching the regime from floating to fixed and switching the regime from fixed to floating have asymmetric impacts on the country risk spread, and it confirms the hypothesis that investors consider breaking an exchange rate peg as breaking central bank’s commitment to monetary stability.

JEL-codes: F3 F31 F41 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:ijc:ijcjou:y:2023:q:3:a:5

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