Excessive Liability Dollarization in a Simple Signaling Model

Damien Besancenot and Radu Vranceanu

No DR 04001, ESSEC Working Papers from ESSEC Research Center, ESSEC Business School

Abstract: If a dollar denominated external debt comes with so many risks, why do emerging economies allow for such an imbalance to accumulate ? The explanation provided in this paper builds on a simple signaling model. By assumption, lenders have no direct possibility to infer a firm’s financial stance. Therefore sound firms might want to borrow dollars and bear a high clearance cost, just in order to signal their type. The success of this policy depends on the behavior of bad firms. When dollar borrowing clearance costs are relatively small with respect to the clearance cost of borrowing in the local currency, the whole private sector would opt for liability dollarization. In this case the signaling effect vanishes, while all firms bear high clearance costs.

Keywords: Original sin; Signaling; Developing countries; Liability dollarization; Perfect Bayesian Equilibrium (search for similar items in EconPapers)
JEL-codes: D82 E44 F34 O16 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2004-01
New Economics Papers: this item is included in nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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