Risk Premiums and Exchange Rate Expectations: A Reassessment of the So-Called Dollar Peg Policies of Crisis East Asian Countries, 1994-97

Shinji Takagi and Taro Esaka

ESRI Discussion paper series from Economic and Social Research Institute (ESRI)

Abstract: We use an unobserved components model to extract the foreign exchange risk premium from the excess ex post returns of East Asian currency assets over US dollar assets and derive the implied expected future spot rates of East Asian currencies against the US dollar. Empirical results, obtained from monthly data on the crisis East Asian countries of Indonesia, Malaysia, Korea and Thailand for the period January 1994-June 1997, generally indicate that the risk premium was substantial and time-varying and that market participants consistently formed expectations of either appreciation or depreciation over the coming month. The presence of a risk premium means that East Asian currency assets and US dollar assets were imperfect substitutes, so that sterilization was effective. The expectations of short-term depreciation or appreciation suggest that the so-called dollar peg policies were not credible. JEL Classification: F31, F32, F33, O53

Keywords: East Asian currency crisis; exchange rate policy in East Asia; foreign exchange risk premium; unobserved components models (search for similar items in EconPapers)
Pages: 39 pages
Date: 2001-06
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