An optimal currency basket to minimize output and inflation volatility : theory and an application to Hong Kong

Zihui MA, Kwok Hon, Leonard CHENG

Research output: Journal PublicationsJournal Article (refereed)peer-review


In this paper we develop a theoretical model of an optimal currency basket for a small open economy. A currency basket for the home economy is defined as a chosen weighted average of a subset of foreign currencies, and an optimal currency basket is taken to be one that minimizes a given weighted average of the expected output volatility and expected inflation volatility. This theoretical model is then applied to Hong Kong, which has adopted a currency board system for close to 30 years. We estimate an optimal currency basket for Hong Kong and compare its performance with the existing currency board system as well as with currency baskets whose weights are given by export and import trade shares.
Original languageEnglish
Pages (from-to)90-111
Number of pages22
JournalPacific Economic Review
Issue number1
Publication statusPublished - Feb 2014

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