Currency peg

An exchange rate regime in which the authorities commit to a stated rate, or to a narrow band around one, against an anchor currency or a basket of them. The commitment is maintained by standing ready to deal in the market at the rate, which requires reserves of the anchor currency. Variants sit along a spectrum: a hard peg or currency board backed by full reserve cover, a band within which the rate may float, and a crawling peg adjusted on a published schedule.

The consequence that matters most is monetary. A country that fixes its rate to another currency largely imports that currency's monetary policy, because holding the rate while running a materially different domestic interest rate invites flows that the authorities would then have to absorb. Pegged pairs therefore show very low realised volatility, their forward pricing is dominated by the interest differential rather than by expectations of the rate, and several currencies in the Gulf region, including the United Arab Emirates dirham and the Saudi riyal, are pegged to the US dollar on this basis.

Low volatility is not low risk, and this is the trip. A peg holds until the authority is unwilling or unable to defend it, and the repricing when one is abandoned is sudden and large rather than gradual, the removal of the Swiss franc's floor against the euro being the standard modern example. Historical volatility measured while a peg held therefore describes the regime rather than the currency, which is precisely why practitioners disagree about how such a series should be used in any risk calculation.