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Endogenous Deposit Dollarization

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Author Info
Broda, Christian
Yeyati, Eduardo Levy

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Abstract

This paper explores sources of deposit dollarization unrelated to standard moral hazard arguments. We argue that the equal treatment of peso and dollar claims on a bank in the event of default can induce banks to attract dollar deposits above the socially desirable level. The distortion arises because dollar depositors are the only source of default risk in the model, but they share the burden of the default with peso depositors as interest rates cannot be set contingent to the (unobserved) level of deposit dollarization. The incentive to dollarize is reinforced by common banking system safety nets such as deposit and bank insurance. Our findings suggest that regulators in bi-currency economies should depart from the currency-blind benchmark and instead distinguish across currencies in a way that prevents undesirable currency mismatches, even in the absence of moral hazard related to the relaxation of market discipline.

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File URL: http://dx.doi.org/10.1353/mcb.2006.0050
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Publisher Info
Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 38 (2006)
Issue (Month): 4 (June)
Pages: 963-988
Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Handle: RePEc:mcb:jmoncb:v:38:y:2006:i:4:p:963-988

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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References listed on IDEAS
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    Other versions:
  2. Girton, Lance & Roper, Don E, 1981. "Theory and Implications of Currency Substitution," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 13(1), pages 12-30, February. [Downloadable!] (restricted)
  3. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 2001. "Prospective Deficits and the Asian Currency Crisis," Journal of Political Economy, University of Chicago Press, vol. 109(6), pages 1155-1197, December. [Downloadable!] (restricted)
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  4. Michael P. Dooley, 1997. "A Model of Crises in Emerging Markets," NBER Working Papers 6300, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk : facts and puzzles from currency boards," Policy Research Working Paper Series 2815, The World Bank. [Downloadable!]
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  6. Demirguc, Asli & Detragiache, Enrica, 2000. "Monitoring Banking Sector Fragility: A Multivariate Logit Approach," World Bank Economic Review, Oxford University Press, vol. 14(2), pages 287-307, May. [Downloadable!]
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  7. Ratna Sahay & Carlos A. Végh Gramont, 1995. "Dollarization in Transition Economies: Evidence and Policy Implications," IMF Working Papers 95/96, International Monetary Fund.
  8. Kareken, John H & Wallace, Neil, 1978. "Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition," Journal of Business, University of Chicago Press, vol. 51(3), pages 413-38, July. [Downloadable!] (restricted)
  9. Pablo Guidotti & Carlos A. Rodríguez, 1992. "Dollarization in Latin America: Gresham's Law in Reverse?," CEMA Working Papers: Serie Documentos de Trabajo. 81, Universidad del CEMA. [Downloadable!]
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  10. G. G. Garcia, 1999. "Deposit Insurance - A Survey of Actual and Best Practices," IMF Working Papers 99/54, International Monetary Fund.
  11. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2001. "Hedging and financial fragility in fixed exchange rate regimes," European Economic Review, Elsevier, vol. 45(7), pages 1151-1193. [Downloadable!] (restricted)
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  12. Thomas, Lee R, 1985. "Portfolio Theory and Currency Substitution," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(3), pages 347-57, August. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jeanne, Olivier, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," CEPR Discussion Papers 4030, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  2. Sánchez-Fung, José R., 2008. "The day-to-day interbank market, volatility, and central bank intervention in a developing economy," MPRA Paper 15648, University Library of Munich, Germany. [Downloadable!]
  3. Alain Ize & Andrew Powell, 2003. "Prudential Responses to De Facto Dollarization," Business School Working Papers defactodollarization, Universidad Torcuato Di Tella. [Downloadable!]
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  4. Diego Winkelried & Juan Francisco Castro & Eduardo Morón, 2004. "Understanding Financial Vulnerability in Partially Dollarized Economies," Econometric Society 2004 Latin American Meetings 260, Econometric Society. [Downloadable!]
  5. Eduardo Levy Yeyati, 2005. "Financial Dollarisation: Evaluating The Consequences," Business School Working Papers findollarisation, Universidad Torcuato Di Tella. [Downloadable!]
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  6. Eduardo Levy Yeyati, 2004. "Dollars, Debt and the IFIs: Dedollarizing Multilateral Lending," Business School Working Papers dedollmultlending, Universidad Torcuato Di Tella. [Downloadable!]
  7. De Nicolo, Gianni & Honohan, Patrick & Ize, Alain, 2003. "Dollarization of the banking system : good or bad?," Policy Research Working Paper Series 3116, The World Bank. [Downloadable!]
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  8. Eduardo Moron & Juan F. Castro, 2003. "Dedollarizing the Peruvian Economy," Macroeconomics 0312005, EconWPA. [Downloadable!]
  9. Eduardo Moron & Juan F. Castro & Diego Winkelried, 2004. "Assessing Financial Vulnerability in Partially Dollarized Economies," International Finance 0406002, EconWPA. [Downloadable!]
  10. Alicia Garcia Herrero & Juan Carlos Berganza, 2004. "What Makes Balance Sheet Effects Detrimental For The Country Risk Premium?," International Finance 0408002, EconWPA. [Downloadable!]
  11. Eduardo Levy Yeyati & Ernesto Schargrodsky & Sebastián Galiani, 2003. "Finantial Dollarization and Debt Deflation under a Currency Board," Business School Working Papers tres, Universidad Torcuato Di Tella. [Downloadable!]
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