Financial Dollarization and the Size of the Fear
AbstractBased on the significance of a Minimum Variance Portfolio (MVP) for the understanding of dollarization equilibria, a significant strand of the debate concerned with the driving forces behind this phenomenon has focused on analyzing the determinants of the relative volatility of inflation vis-à-vis real depreciation. This analysis contributes in the identification of those factors by extending the basic CAPM formulation via the introduction of credit risk that is directly linked to the shock that determines real returns for dollar denominated assets: unanticipated shifts in the real exchange rate. We show this ingredient can end up altering the perceived relative volatility of peso and dollar assets in a way that fuels financial dollarization (by increasing the relative hedging opportunities offered by the latter). We calibrate our model using Peruvian data for the period 1998-2004, and its predictions show a better fit with observed financial dollarization ratios than those of the basic CAPM model.
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Bibliographic InfoPaper provided by EconWPA in its series Macroeconomics with number 0509027.
Length: 24 pages
Date of creation: 30 Sep 2005
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Financial dollarization; Minimum Variance Portfolio; Peru;
Other versions of this item:
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- C34 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Truncated and Censored Models; Switching Regression Models
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-10-08 (All new papers)
- NEP-FMK-2005-10-08 (Financial Markets)
- NEP-IFN-2005-10-08 (International Finance)
- NEP-MAC-2005-10-08 (Macroeconomics)
- NEP-MON-2005-10-08 (Monetary Economics)
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