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Endogenous deposit dollarization

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Author Info

  • Christian Broda
  • Eduardo Levy Yeyati

Abstract

This paper explores sources of deposit dollarization unrelated to standard moral hazard arguments. We develop a model in which banks choose the optimal currency composition of their liabilities. We argue that the equal treatment of peso and dollar claims in the event of bank default can induce banks to attract dollar deposits above the socially desirable level. The distortion arises because dollar deposits are the only source of default risk in the model, but dollar depositors share the burden of the default with peso depositors. 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 would potentially benefit by departing from the currency-blind benchmark and differentiating among currencies in a way that prevents undesirable currency mismatches.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 160.

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Date of creation: 2003
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Handle: RePEc:fip:fednsr:160

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Related research

Keywords: Bank deposits ; Foreign exchange ; Currency convertibility;

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References

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  1. 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.
  2. Maurice Obstfeld, 1998. "The Global Capital Market: Benefactor or Menace?," NBER Working Papers 6559, National Bureau of Economic Research, Inc.
  3. Michael P. Dooley, 1997. "A Model of Crises in Emerging Markets," NBER Working Papers 6300, National Bureau of Economic Research, Inc.
  4. Sahay, Ratna & Vegh, Carlos, 1995. "Dollarization in transition economies: Evidence and policy implications," MPRA Paper 20490, University Library of Munich, Germany.
  5. Sergio L. Schmukler & Luis Serven, 2002. "Pricing Currency Risk: Facts and Puzzles from Currency Boards," NBER Working Papers 9047, National Bureau of Economic Research, Inc.
  6. Demirguc, Asli & Detragiache, Enrica, 2000. "Monitoring Banking Sector Fragility: A Multivariate Logit Approach," World Bank Economic Review, World Bank Group, vol. 14(2), pages 287-307, May.
  7. Pablo E. Guidotti & Carlos A. Rodriguez, 1992. "Dollarization in Latin America: Gresham's Law in Reverse?," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 518-544, September.
  8. Burnside, C. & Eichenbaum, M. & Rebelo, S., 1998. "Prospective Deficits and the Asian Currency Crisis," RCER Working Papers 458, University of Rochester - Center for Economic Research (RCER).
  9. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1999. "Hedging and financial fragility in fixed exchange rate regimes," Working Paper Series WP-99-11, Federal Reserve Bank of Chicago.
  10. Thomas, Lee R, 1985. "Portfolio Theory and Currency Substitution," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(3), pages 347-57, August.
  11. Uribe, Martin, 1997. "Hysteresis in a simple model of currency substitution," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 185-202, September.
  12. Kareken, John H & Wallace, Neil, 1978. "Deposit Insurance and Bank Regulation: A Partial-Equilibrium Exposition," The Journal of Business, University of Chicago Press, vol. 51(3), pages 413-38, July.
  13. G. G. Garcia, 1999. "Deposit Insurance - A Survey of Actual and Best Practices," IMF Working Papers 99/54, International Monetary Fund.
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  1. User:Thuydnguyen87/sandbox in Wikipedia (English)
  2. Dollarization in Wikipedia (English)

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