Original sin and the great depression

Abstract

Do exchange rate movements matter for how markets price foreign currency denominated sovereign bonds? High-frequency bond price data from 1931 show that depreciation against the dollar/gold was associated with elevated risk premia on US dollar/gold public debt. We use a theoretical model to illustrate how foreign currency debt influences exchange rate policy and foreign currency bond prices. We use these theoretical results, the timing of sterling's devaluation in September 1931, and historically determined fundamentals to identify the impact of exchange rate policy on hard-currency bond yields in the Great Depression.