Magazine article Chicago Policy Review (Online)

Uncertainty in Financial Markets and the Exchange Risk Premium of the Mexican Peso

Magazine article Chicago Policy Review (Online)

Uncertainty in Financial Markets and the Exchange Risk Premium of the Mexican Peso

Article excerpt

Since 2015, the Mexican Peso has been the second most depreciated currency among emerging countries. This depreciation is mostly due to the operating and liquidity conditions of the currency, since it can be traded twenty-four hours a day, seven days a week, which is a relatively uncommon feature among currencies. According to the last triennial survey (2016) of the Bank of International Settlements, the Mexican Peso is the tenth most traded currency across the globe.

In an environment of risk-averse international financial markets, the Mexican Peso is further depreciated because of its use as a proxy for other emerging currencies. In this context of upward pressures on the Mexican Peso, Guillermo Benavides, in his article, “Exchange Rate Risk Premium: An Analysis of its Determinants for the Mexican Peso-USD”, analyzes the determinants of the exchange risk premium (ERP) of the Mexican Peso-US Dollar (USD) exchange rate from 2007-2015 using two econometric models: linear regression and vector autoregression. The exchange risk premium is the amount of additional money an investor demands to be compensated for a depreciation of one currency with respect to another. In this case, the investor holds or plans to hold a long-term position in the currency.

From 2007-2015, the ERP had three peaks as a result of high volatility events in global financial markets. In October 2008, the Mexican Peso depreciated 19 percent during the global financial crisis. In September 2011, the ERP spiked a second time as a result of Greece’s financial crisis. Eventually the ERP decreased, but in May 2013 it increased once again during the Taper Tantrum occurrence, at which time there was an expected reduction in bond purchases by the Federal Reserve. …

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