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Dollarization: An Irreversible Decision

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  • Roger Craine

    (University of California, Berkeley)

Abstract

If dollarization is a credible commitment to maintain a fixed exchange rate, then it is an irreversible decision. This paper explicitly models the unique feature -- irreversibility -- of a dollarization policy. In addition, it is the first paper to recognize that if a dollarization is a potential exchange rate regime choice, then the equilibrium is a mixed strategy equilibrium. The case of Argentina's possible dollarization is considered. I compute Nash equilibria and the transition probabilities that a country will move from a currency board regime to dollarizing, or floating, in one year, or two years, out to seven years. I model shocks to the exchange rate as a jump-diffusion process. The jumps represent large "asymmetric" shocks to the exchange rate -- such as Brazil's 1999 devaluation. The probability of dollarization is inversely related to the jump probability.

Suggested Citation

  • Roger Craine, 2001. "Dollarization: An Irreversible Decision," International Finance 0103003, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpif:0103003
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    References listed on IDEAS

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    Cited by:

    1. Henri Bourguinat & Larbi Dohni, 2002. "La dollarisation comme solution en dernier ressort," Revue Française d'Économie, Programme National Persée, vol. 17(1), pages 57-96.

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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