Download This PaperSovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy
49 Pages Posted: 7 Feb 2017 Last revised: 13 Jan 2020
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Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy
Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy
Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy
Date Written: January 10, 2020
Abstract
We document that governments whose local currency debt provides them with greater hedging benefits actually borrow more in foreign currency. We introduce two features into a government's debt portfolio choice problem to explain this finding: risk-averse lenders and lack of monetary policy commitment. A government without commitment chooses excessively counter-cyclical inflation ex post, which leads risk-averse lenders to require a risk premium ex ante. This makes local currency debt too expensive from the government's perspective and thereby discourages the government from borrowing in its own currency.
Keywords: local currency debt, bond betas, inflation cyclicality, bond risk premia, inflation commitment
JEL Classification: G12, G15, E3
Suggested Citation: Suggested Citation
Wenxin Du
University of Chicago Booth School of Business ( email )
5807 South Woodlawn Avenue
Chicago, IL 60637
United States
Jesse Schreger
Columbia University - Columbia Business School, Economics ( email )
420 West 118th Street
New York, NY 10027
United States