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

  • Enrique L. Kawamura

    ()

    (Department of Economics, Universidad de San Andres)

  • Daniel Heymann

    (ECLAC)

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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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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  1. Alain Ize & Andrew Powell, 2004. "Prudential Responses to De Facto Dollarization," IMF Working Papers 04/66, International Monetary Fund.
  2. Fischer, Stanley, 1975. "The Demand for Index Bonds," Journal of Political Economy, University of Chicago Press, vol. 83(3), pages 509-34, June.
  3. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May.
  4. Roberto Chang & Andres Velasco, 2004. "Monetary policy and the currency denomination of debt: a tale of two equilibria," Working Paper Series 2004-30, Federal Reserve Bank of San Francisco.
  5. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, vol. 59(2), pages 323-347, March.
  6. Alain Ize & Eric Parrado, 2002. "Dollarization, Monetary Policy, and the Pass-Through," IMF Working Papers 02/188, International Monetary Fund.
  7. Neumeyer, P.A., 1995. "Currencies and the Allocation of Risk: The Welfare Effect of a Monetary Union," DELTA Working Papers 95-27, DELTA (Ecole normale supérieure).
  8. Jeanne, Olivier, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," CEPR Discussion Papers 4030, C.E.P.R. Discussion Papers.
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