Hedging and financial fragility in fixed exchange rate regimes

Burnside, C. (2001) Hedging and financial fragility in fixed exchange rate regimes. European Economic Review, 45(7), pp. 1151-1193. (doi: 10.1016/S0014-2921(01)00090-3)

Full text not currently available from Enlighten.

Publisher's URL: http://dx.doi.org/10.1016/S0014-2921(01)00090-3

Abstract

Currency crises that coincide with banking crises tend to share at least three elements. First, banks have a currency mismatch between their assets and liabilities. Second, banks do not completely hedge the associated exchange rate risk. Third, there are implicit government guarantees to banks and their foreign creditors. This paper argues that the first two features arise from banks’ optimal response to government guarantees. We show that guarantees completely eliminate banks’ incentives to hedge the risk of a devaluation. Our model also articulates one reason why governments might be tempted to provide guarantees to bank creditors. Guarantees lower the domestic interest rate and lead to a boom in economic activity. But this boom comes at the cost of a more fragile banking system. In the event of a devaluation, banks renege on foreign debts and declare bankruptcy.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Burnside, Professor Craig
Authors: Burnside, C.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:European Economic Review
ISSN:0014-2921

University Staff: Request a correction | Enlighten Editors: Update this record