Peso Problem

Peso Problem

The phenomenon in which the market prices in (or takes into account when determining the price) the small possibility of a large change. The term especially refers to exchange rates of pegged currencies, which may be slightly different from the official rates to account for the probability that currencies will drop or change their pegs.
References in periodicals archive ?
This finding is consistent with the view that the average payoff to the unhedged carry trade reflects a peso problem.
Rebelo, "Do Peso Problems Explain the Returns to the Carry Trade?
Financial markets refer to this phenomenon--the incorporation of a premium for the small probability of a big, discrete price change--as the peso problem, after a similar event during the early 1970s in the market for Mexican pesos.
An alternative approach to the "drift adjustment method" is presented, which takes care of the peso problem and provides consistent estimates of the expected rate of realignment.
13) explain the peso problem this way: "Suppose that short-term interest rates can evolve in three different regimes, with the mean and volatility of rates increasing together as we move across regimes.