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Excessive Liability Dollarization in a Simple Signaling Model

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Author Info

  • Besancenot, Damien

    ()
    (Université de Paris 2)

  • Vranceanu, Radu

    ()
    (ESSEC Business School)

Abstract

If a dollar denominated external debt comes with so many risks, why do emerging economies allow for such an imbalance to accumulate ? The explanation provided in this paper builds on a simple signaling model. By assumption, lenders have no direct possibility to infer a firm’s financial stance. Therefore sound firms might want to borrow dollars and bear a high clearance cost, just in order to signal their type. The success of this policy depends on the behavior of bad firms. When dollar borrowing clearance costs are relatively small with respect to the clearance cost of borrowing in the local currency, the whole private sector would opt for liability dollarization. In this case the signaling effect vanishes, while all firms bear high clearance costs.

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Bibliographic Info

Paper provided by ESSEC Research Center, ESSEC Business School in its series ESSEC Working Papers with number DR 04001.

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Length: 26 pages
Date of creation: Jan 2004
Date of revision:
Handle: RePEc:ebg:essewp:dr-04001

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Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
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Web page: http://www.essec.edu/
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Related research

Keywords: Original sin; Signaling; Developing countries; Liability dollarization; Perfect Bayesian Equilibrium;

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References

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  1. Paul Krugman, 2000. "Crises : the price of globalization?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 75-106.
  2. Jeromin Zettelmeyer & Olivier Jeanne, 2002. "Original Sin, Balance Sheet Crises, and the Roles of International Lending," IMF Working Papers 02/234, International Monetary Fund.
  3. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2001. "Currency crises and monetary policy in an economy with credit constraints," European Economic Review, Elsevier, vol. 45(7), pages 1121-1150.
  4. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2014. "Addicted to Dollars," Annals of Economics and Finance, Society for AEF, vol. 15(1), pages 1-50, May.
  5. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 329-368.
  6. Kenneth Rogoff, 1999. "International Institutions for Reducing Global Financial Instability," NBER Working Papers 7265, National Bureau of Economic Research, Inc.
  7. Ricardo J. Caballero & Arvind Krishnamurthy, 2000. "Dollarization of Liabilities: Underinsurance and Domestic Financial Underdevelopment," NBER Working Papers 7792, National Bureau of Economic Research, Inc.
  8. repec:rus:hseeco:123906 is not listed on IDEAS
  9. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, vol. 59(2), pages 323-347, March.
  10. Besancenot, Damien & Vranceanu, Radu, 2003. "Financial Instability under Floating Exchange Rates," ESSEC Working Papers DR 03011, ESSEC Research Center, ESSEC Business School.
  11. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
  12. Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August.
  13. Cowan, kevin & Quy-Toan Do, 2003. "Financial dollarization and central bank credibility," Policy Research Working Paper Series 3082, The World Bank.
  14. Jeanne, Olivier, 2000. "Foreign currency debt and the global financial architecture," European Economic Review, Elsevier, vol. 44(4-6), pages 719-727, May.
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Citations

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Cited by:
  1. Martin Brown & Steven Ongena & Pinar Yesin, 2009. "Foreign Currency Borrowing by Small Firms," Working Papers 2009-02, Swiss National Bank.
  2. Brown, M. & Ongena, S. & Yesin, P., 2008. "Currency Denomination of Bank Loans: Evidence from Small Firms in Transition Countries," Discussion Paper 2008-16, Tilburg University, Center for Economic Research.

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