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On Liability Dollarization: A Simple Model with Domestic and Foreign Creditors

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  • Enrique L. Kawamura

    ()
    (Department of Economics, Universidad de San Andres)

  • Daniel Heymann

    (ECLAC)

Abstract

This paper presents a simple model of debt contracts in order to analyze the conditions under which domestic residents would choose to currency denomination of debt. In the model, borrowers are producers of non-traded goods and subject to real exchange rate shocks, that constitute the source of real shocks in the model. There is a domestic unit of account; prices in terms of that unit can be shocked by a (presumably policy-induced) disturbance. Debt obligations can be denominated in either traded goods (dollarized contracts) or local currency. When real and nominal shocks are possitively correlated, dollarized contracts tend to be preferable to (non-contingent) nominal contracts when nominal shocks are large and real shocks are small. When foreign risk-neutral investors are added to the model, we show that in equilibrium all domestic lenders invest their funds in (riskfree) foreign investment opportunities, and so local borrowers must fund their projects from the foreign lenders.

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File URL: ftp://webacademicos.udesa.edu.ar/pub/econ/doc80.pdf
File Function: First version, 2005
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Bibliographic Info

Paper provided by Universidad de San Andres, Departamento de Economia in its series Working Papers with number 80.

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Length: 41 pages
Date of creation: Feb 2005
Date of revision: Feb 2005
Handle: RePEc:sad:wpaper:80

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Related research

Keywords: dollarization; domestic creditors; foreign creditors;

References

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  1. Alain Ize & Andrew Powell, 2005. "Prudential Responses to de facto Dollarization," Journal of Economic Policy Reform, Taylor & Francis Journals, Taylor & Francis Journals, vol. 8(4), pages 241-262.
  2. Neumeyer, P.A., 1995. "Currencies and the Allocation of Risk: The Welfare Effect of a Monetary Union," DELTA Working Papers, DELTA (Ecole normale supérieure) 95-27, DELTA (Ecole normale supérieure).
  3. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 117(2), pages 379-408, May.
  4. Alain Ize & Eric Parrado, 2002. "Dollarization, Monetary Policy, and the Pass-Through," IMF Working Papers 02/188, International Monetary Fund.
  5. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, Elsevier, vol. 59(2), pages 323-347, March.
  6. Andres Velasco & Roberto Chang, 2004. "Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria," NBER Working Papers 10827, National Bureau of Economic Research, Inc.
  7. Olivier Jeanne, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," IMF Working Papers 03/177, International Monetary Fund.
  8. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 83(3), pages 509-34, June.
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Cited by:
  1. Roberto Cortes Conde, 2008. "Spanish America Colonial Patterns: The Rio de La Plata," Working Papers, Universidad de San Andres, Departamento de Economia 96, Universidad de San Andres, Departamento de Economia, revised Mar 2008.

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