Salle 3001

Pablo WINANT (CREST/ESCP/Polytechnique) “Insurability and Premia in Foreign Exchange Markets”

Abstract: We propose a tractable small-open-economy framework in which uncovered interest parity premia on foreign exchange (FX) markets are related to the endogenous insurability of exchange rates. Asymmetric information about monetary policy can make the tails of the exchange rate distribution uninsurable in FX hedging markets, which in turn generates premia in FX spot markets. There is a role for government intervention because of an information sensitivity externality: agents do not internalize that their actions can cause more exchange rates to become uninsurable. The framework reveals that premia may be amplified by weaknesses in monetary, fiscal, and financial policy frameworks. Premia can be mitigated through macroeconomic policy reforms which reduce the sensitivity of exchange rates to private information. The constrained efficient policy remedies depend on country-specific characteristics such as the composition of lenders holding the external debt. Possible remedies include delegation of monetary policy to an “aloof central banker”, constraints on fiscal policy, more active use of macroprudential tools, and institutions designed to publish or hide information.

Joint work : Suman Basu (IMF).