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Exchange Rate Pegs and Foreign Exchange Exposure in East and South East Asia - page 12 / 33

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either to the dollar or to the crisis period, evidence of exposure is strongest against the

dollar, and it is strongest around the time of the crisis.

III. Exposure and Exchange Rate Arrangements

Having gauged the residual foreign exchange exposure, we next examine its

empirical link to exchange rate arrangements. It is sometimes argued that a fixed exchange

rate regime offers a hospitable environment for business by providing stability and

removing the need for expensive hedging. However, even in the rare case of a stable

exchange rate peg, the exchange rate cannot be fixed independently against more than one

currency. If it is fixed against, say, the U.S. dollar, it is left to fluctuate freely against the

yen and the euro. So, firms remain exposed to foreign exchange risk even when their

currency officially is fixed. A firm’s value may be quite sensitive to exchange rate

fluctuations in this setting. In contrast, firms in countries with freely floating currencies

may be accustomed to hedging, and hedging may be less costly in such countries.15 Thus,

it is not clear which arrangement will see more foreign exchange exposure overall.

The exchange rate arrangements themselves entail mixtures of various monetary

instruments. While in the countries that we study the arrangement is identified easily, it is

15 As emphasized by an anonymous referee, deviations from purchasing power parity (PPP) may differ across exchange rate arrangements, giving rise to differing degrees of exchange rate exposure for that reason. (See Parsley and Popper, 2001, for an assessment of PPP under alternative exchange rate arrangements.) In this regard, what should matter is the real exchange rate, not the nominal exchange rate, which we use. However, the empirical fact that nominal exchange rates are so much more volatile than prices at frequencies less than one year means that the correlation between nominal and real exchange rate changes is extremely high. This suggests that it is very likely that the results we report here would extend to real exchange rates, were we able to measure them at this frequency. (Price data, hence real exchange rates, are only available monthly.)

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