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The Credibility of Hong Kong's Link from the Perspective of Modern Financial Theory


  • An earlier version of this paper was completed when Hans Genberg was Executive Director, Research Department at the Hong Kong Monetary Authority. The views expressed in this paper are the authors’ and do not necessarily represent those of the International Monetary Fund or the Hong Kong Monetary Authority. The authors gratefully acknowledge incisive comments from Charles Goodhart, Pierre Siklos, and the participants of the conference “Hong Kong's Currency Board at 25” held at the Institute of Historical Research, London on October 21, 2008, the editor and two anonymous referees, as well as assistance from Laurence Fung, Tom Fong, Georgina Lok, and in particular Bill Chung.


Hong Kong's linked exchange rate system (LERS) has been in operation since 1983, during which time many other fixed exchange rate systems have succumbed to shocks and/or speculative attacks. This paper investigates how market participants assessed changes made to the LERS by using the tools of modern finance to extract information from financial asset prices about market expectations. These changes have been characterized as making the system less discretionary over time. We find that decreasing the discretionary element of the LERS led to an increase in credibility of the arrangement.