The Effect of the Lebanese Peg to the US Dollar on Market Efficiency and Risk

Abstract

The theory of self-fulfilling currency attacks predicts that pegged foreign exchange rates are extremely sensitive to adverse and hostile speculation. This is true whenever fiscal policy and monetary policy are inconsistent with each other, or even when intensive and public official intervention is initiated by a central bank with limited foreign exchange reserves. The experience of Lebanon, with its peg to the US-dollar since December 1998, shows that contrary to the received wisdom, a peg can stabilise the financial markets and eliminate inefficiencies such as serial correlation, a bias of the forward rate and the presence of a Peso problem. Moreover, risk was not only reduced during the Lebanese peg but was also dissipated.