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Sovereign Debt Portfolios, Bond Risks, and the Credibility of Monetary Policy
Author(s) -
DU WENXIN,
PFLUEGER CAROLIN E.,
SCHREGER JESSE
Publication year - 2020
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12965
Subject(s) - monetary economics , debt , currency , portfolio , credibility , bond , foreign exchange risk , economics , government debt , internal debt , local currency , monetary policy , external debt , ex ante , inflation (cosmology) , financial system , business , financial economics , finance , fiscal policy , macroeconomics , political science , law , physics , theoretical physics
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.