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Endogenous Deposit Dollarization

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  • 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 di.erentiating among currencies in a way that prevents undesirable currency mismatches.

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File URL: http://www.utdt.edu/departamentos/empresarial/cif/pdfs-wp/wpcif-012003.pdf
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Bibliographic Info

Paper provided by Universidad Torcuato Di Tella in its series Business School Working Papers with number dieciseis.

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Length: 33 pages
Date of creation: Feb 2003
Date of revision:
Handle: RePEc:udt:wpbsdt:dieciseis

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  1. Thomas, Lee R, 1985. "Portfolio Theory and Currency Substitution," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 17(3), pages 347-57, August.
  2. 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.
  3. Martin Uribe, 1995. "Hysteresis in a simple model of currency substitution," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 509, Board of Governors of the Federal Reserve System (U.S.).
  4. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk : facts and puzzles from currency boards," Policy Research Working Paper Series 2815, The World Bank.
  5. Demirguc, Asli & Detragiache, Enrica, 2000. "Monitoring Banking Sector Fragility: A Multivariate Logit Approach," World Bank Economic Review, World Bank Group, World Bank Group, vol. 14(2), pages 287-307, May.
  6. Adam Bennett & Eduardo Borensztein & Tomás J. T. Baliño, 1999. "Monetary Policy in Dollarized Economies," IMF Occasional Papers 171, International Monetary Fund.
  7. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 2001. "Prospective Deficits and the Asian Currency Crisis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 109(6), pages 1155-1197, December.
  8. Maurice Obstfeld, 1998. "The Global Capital Market: Benefactor or Menace?," NBER Working Papers 6559, National Bureau of Economic Research, Inc.
  9. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1999. "Hedging and Financial Fragility in Fixed Exchange Rate Regimes," NBER Working Papers 7143, National Bureau of Economic Research, Inc.
  10. Girton, Lance & Roper, Don E, 1981. "Theory and Implications of Currency Substitution," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 13(1), pages 12-30, February.
  11. Michael P. Dooley, 1997. "A Model of Crises in Emerging Markets," NBER Working Papers 6300, National Bureau of Economic Research, Inc.
  12. Blum, Jurg, 1999. "Do capital adequacy requirements reduce risks in banking?," Journal of Banking & Finance, Elsevier, vol. 23(5), pages 755-771, May.
  13. 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.
  14. Carlos A. Végh Gramont & Ratna Sahay, 1995. "Dollarization in Transition Economies," IMF Working Papers 95/96, International Monetary Fund.
  15. G. G. Garcia, 1999. "Deposit Insurance," IMF Working Papers 99/54, International Monetary Fund.
  16. Sahay, Ratna & Vegh, Carlos, 1995. "Dollarization in transition economies: Evidence and policy implications," MPRA Paper 20490, University Library of Munich, Germany.
  17. Alexander Kyei, 1995. "Deposit Protection Arrangements: A Survey," IMF Working Papers 95/134, International Monetary Fund.
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