What is the "peso problem"?
A) Expectations are realized on average, and returns from interest arbitrage are zero.
B) Even when exchange rates are fixed, investors often demand a premium for interest arbitrage, so the return from arbitrage can be positive or negative.
C) Pegged currencies are less stressful for investors because there is no room for speculation.
D) Returns from interest arbitrage are always positive, even when the peg breaks.

Question

Quizplus · Accepted Answer

The "peso problem" refers to the situation where a country with a fixed exchange rate experiences a devaluation of its currency, causing investors to demand a premium for interest arbitrage. This can lead to a situation where the return from arbitrage is either positive or negative, and can result in financial instability.

What Is the "Peso Problem