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Financial Dollarization and the Size of the Fear

  • Juan F. Castro

    (Universidad del Pacífico)

  • Eduardo Morón

    (Universidad del Pacífico)

Based 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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File URL: http://128.118.178.162/eps/mac/papers/0509/0509027.pdf
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Paper provided by EconWPA in its series Macroeconomics with number 0509027.

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Length: 24 pages
Date of creation: 30 Sep 2005
Date of revision:
Handle: RePEc:wpa:wuwpma:0509027
Note: Type of Document - pdf; pages: 24
Contact details of provider: Web page: http://128.118.178.162

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  1. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2007. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 295-330, 03.
  2. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
  3. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Addicted to Dollars," NBER Working Papers 10015, National Bureau of Economic Research, Inc.
    • Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Addicted to Dollars," CEMA Working Papers 594, China Economics and Management Academy, Central University of Finance and Economics.
  4. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  5. Juan Castro & Eduardo Morón & Diego Winkelried, 2004. "Assessing Financial Vulnerability in Partial Dollarized Economies," Working Papers 04-03, Departamento de Economía, Universidad del Pacífico, revised Nov 2004.
  6. Alain Ize, 2005. "Financial Dollarization Equilibria; A Framework for Policy Analysis," IMF Working Papers 05/186, International Monetary Fund.
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