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Journal of Finance Vol. 75 No. 6 2020

Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy

Wenxin Du; Carolin Pflueger1; Jesse Schreger2,1,3,4,5,6

1 University of Chicago · 2 Hatch (Canada) · 3 Universitatea Andrei Şaguna · 4 Fondazione Vincenzo Pansadoro · 5 Campbell Collaboration · 6 Federal Reserve Bank of Chicago

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 countercyclical 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.

DOI
10.1111/jofi.12965
Volume
75
Issue
6
Pages
3097-3138
Language
en
Sources
bibtex:phds-export.bib crossref openalex

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