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Financial dollarization and systemic risks: New empirical evidence

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  • Vieira, Fabrício A.C.
  • Holland, Márcio
  • Resende, Marco F.

Abstract

This paper explores the persistence of financial dollarization in a group of 79 economies with different levels of development. Our main hypothesis is that a high level of domestic debt combined with default risk explains this persistence, even after a decline in inflation rates. Using the generalized method of moments (GMM) in a panel data analysis, our results show that inflation risks caused by increasing probability of default account for financial dollarization more than inflation rate itself. After the decrease in inflation rates, the foreign currency-denominated deposits remain large because of the high debt-to-GDP ratios, particularly in speculative-grade economies. High public indebtedness leads to expectations of default. Dollarization is a rational response to the future inflation associated with investors' expectations of default observed in highly indebted economies.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 31 (2012)
Issue (Month): 6 ()
Pages: 1695-1714

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Handle: RePEc:eee:jimfin:v:31:y:2012:i:6:p:1695-1714

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Web page: http://www.elsevier.com/locate/inca/30443

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Keywords: Financial dollarization; Risk of inflation; Risk of default;

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Cited by:
  1. Neanidis, Kyriakos C. & Savva, Christos S., 2013. "Institutions and financial dollarization: Indirect effects based on a policy experiment," Economics Letters, Elsevier, vol. 121(3), pages 405-410.

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