Mexico'S Currency Risk Premia in 1992-1994: A Closer Look At the Interest Rate Differentials

IMF Working Papers, April 1, 1996

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Mexico'S Currency Risk Premia in 1992-1994: A Closer Look At the Interest Rate Differentials

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Bibliographic details

• Authors: Alejandro M. Werner
• Published: April 1, 1996
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451846058.001

Summary findings

• The paper studies the behavior of interest rate differentials in Mexico during the 1992-94 period.
• The currency risk premia is positively related to the share of peso denominated debt in total debt.
• For every 1 percentage point increase in the ratio of peso denominated debt in total debt, the interest rate differential increases between 20 and 30 basis points.
• After adjusting the observed interest rate differential for the change in the composition of public debt, the adjusted measure remained at extremely high levels throughout 1994, signalling a low level of confidence in the announced currency band.

Key quantitative results

• "For every 1 percentage point increase in the ratio of peso denominated debt in total debt, the interest rate differential increases between 20 and 30 basis points."
• The adjusted interest rate differential remained at extremely high levels throughout 1994 (no alternative numeric values provided in the source).

Method and adjustment

• The observed interest rate differential was adjusted to account for changes in the composition of public debt to better measure the expectation of a devaluation during the period.
• Contrast between unadjusted interest rate differentials and the adjusted measure highlights the role of debt composition in observed premia.

Implications and interpretation

• The sizable effect of the share of peso-denominated debt on interest rate differentials implies that shifts in public debt composition materially influenced currency risk premia during 1992-94.
• The persistence of high adjusted premia throughout 1994 signals low confidence in the announced currency band despite movements in the raw interest rate differential.

Subjects and keywords

• Subjects: Crawling peg, Currencies, Depreciation, Exchange rates, Foreign exchange, Money, National accounts, Return on investment
• Keywords: Crawling peg, Currencies, currency risk premium, Depreciation, depreciation expectation, exchange rate, Exchange rates, interest rate differential, keeping peso interest rates, Return on investment, risk premium, share of Cetes, WP

Source: Alejandro M. Werner, "Mexico'S Currency Risk Premia in 1992-1994: A Closer Look At the Interest Rate Differentials", IMF Working Papers, April 1, 1996.