Currency Board, Asian Financial Crisis, and the Case for Put Options

Francis T. LUI; Leonard K. CHENG; Yum K. KWAN

doi:10.1007/978-1-4615-1041-3_10

Currency Board, Asian Financial Crisis, and the Case for Put Options

Francis T. LUI^*, Leonard K. CHENG, Yum K. KWAN

^*Corresponding author for this work

Research output: Book Chapters | Papers in Conference Proceedings › Book Chapter › Research › peer-review

Abstract

The chapter reviews the circumstances under which speculative attacks on the currency board of Hong Kong occurred during the Asian financial turmoil. It is shown that the conventional defense mechanism via interest arbitrage has not functioned properly. An alternative approach of issuing put options to strengthen the currency board is evaluated. We show that the “technical” measures eventually undertaken by the Hong Kong Monetary Authority (HKMA) in September 1998 are functionally equivalent to issuing the put options, thereby providing a natural experiment of this idea. Based on credibility measures extracted from financial market data since the inception of the board in 1983, we find that interest rate arbitrage had been working properly until the rule-bound currency board was eroded by central bank-like, discretionary policies pursued by the HKMA. However, after implementing the put options proposal, which effectively put the HKMA back onto the rule-bound track, interest rate arbitrage appeared to be effective again.

Original language	English
Title of host publication	Exchange Rate Regimes and Macroeconomic Stability
Editors	Lok-Sang HO, Chi-Wa YUEN
Place of Publication	United States
Publisher	Springer US
Chapter	10
Pages	185-214
Number of pages	30
ISBN (Electronic)	9781461510413
ISBN (Print)	97814613-53652
DOIs	https://doi.org/10.1007/978-1-4615-1041-3_10
Publication status	Published - 2003
Externally published	Yes

Bibliographical note

An earlier version of this paper was presented at the American Economic Association/Chinese Economists Society meetings in New York City on January 4, 1999. We are indebted to K.C. Chan, Yuk-Shee Chan, Zhaohui Chen, and Merton Miller for useful discussions and comments. Alex Chan and Nai-fu Chen deserve special credits for originating some of the ideas in this paper. In a sense they are collaborators of the paper. All remaining errors are ours. Financial support from the Research Grant Council of Hong Kong (grant number HKUST6217/97H) and the City University of Hong Kong (grant number 7001140) is gratefully acknowledged.

Keywords

Exchange Rate
Interest Rate
Exchange Rate Regime
High Interest Rate
Monetary Authority

Access to Document

10.1007/978-1-4615-1041-3_10

1 Book (Editor)

Exchange rate regimes and macroeconomic stability
HO, L. S. (ed.) & YUEN, C. W. (ed.), 2003, Kluwer Academic Publishers.
Research output: Scholarly Books | Reports | Literary Works › Book (Editor) › Education

Cite this

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abstract = "The chapter reviews the circumstances under which speculative attacks on the currency board of Hong Kong occurred during the Asian financial turmoil. It is shown that the conventional defense mechanism via interest arbitrage has not functioned properly. An alternative approach of issuing put options to strengthen the currency board is evaluated. We show that the “technical” measures eventually undertaken by the Hong Kong Monetary Authority (HKMA) in September 1998 are functionally equivalent to issuing the put options, thereby providing a natural experiment of this idea. Based on credibility measures extracted from financial market data since the inception of the board in 1983, we find that interest rate arbitrage had been working properly until the rule-bound currency board was eroded by central bank-like, discretionary policies pursued by the HKMA. However, after implementing the put options proposal, which effectively put the HKMA back onto the rule-bound track, interest rate arbitrage appeared to be effective again.",

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N2 - The chapter reviews the circumstances under which speculative attacks on the currency board of Hong Kong occurred during the Asian financial turmoil. It is shown that the conventional defense mechanism via interest arbitrage has not functioned properly. An alternative approach of issuing put options to strengthen the currency board is evaluated. We show that the “technical” measures eventually undertaken by the Hong Kong Monetary Authority (HKMA) in September 1998 are functionally equivalent to issuing the put options, thereby providing a natural experiment of this idea. Based on credibility measures extracted from financial market data since the inception of the board in 1983, we find that interest rate arbitrage had been working properly until the rule-bound currency board was eroded by central bank-like, discretionary policies pursued by the HKMA. However, after implementing the put options proposal, which effectively put the HKMA back onto the rule-bound track, interest rate arbitrage appeared to be effective again.

AB - The chapter reviews the circumstances under which speculative attacks on the currency board of Hong Kong occurred during the Asian financial turmoil. It is shown that the conventional defense mechanism via interest arbitrage has not functioned properly. An alternative approach of issuing put options to strengthen the currency board is evaluated. We show that the “technical” measures eventually undertaken by the Hong Kong Monetary Authority (HKMA) in September 1998 are functionally equivalent to issuing the put options, thereby providing a natural experiment of this idea. Based on credibility measures extracted from financial market data since the inception of the board in 1983, we find that interest rate arbitrage had been working properly until the rule-bound currency board was eroded by central bank-like, discretionary policies pursued by the HKMA. However, after implementing the put options proposal, which effectively put the HKMA back onto the rule-bound track, interest rate arbitrage appeared to be effective again.

KW - Exchange Rate

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KW - High Interest Rate

KW - Monetary Authority

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A2 - HO, Lok-Sang

A2 - YUEN, Chi-Wa

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CY - United States

ER -

Currency Board, Asian Financial Crisis, and the Case for Put Options

Abstract

Bibliographical note

Keywords

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Research output

Exchange rate regimes and macroeconomic stability

Cite this