Monetary policy, default risk and the exchange rate

In a country with high probability of default, higher interest rates may render the currency lessattractive if sovereign default is costly. This paper develops that intuition in a simple model andestimates the effect of changes in interest rates on the exchange rate in Brazil using data from thedates surrounding the monetary policy committee meetings and the methodology of identi…ficationthrough heteroskedasticity. Indeed, we fi…nd that unexpected increases in interest rates tend to leadthe Brazilian currency to depreciate.[...]