Dollarization of Financial Intermediation: Causes and Policy Implications

Eduardo Levy Yeyati and Alain Ize

No 1998/028, IMF Working Papers from International Monetary Fund

Abstract: This paper presents a portfolio model of financial intermediation in which currency choice is determined by hedging decisions on both sides of a bank’s balance sheet. Minimum variance portfolio (MVP) allocations are found to provide a natural benchmark to estimate the scope for dollarization of bank deposits and loans as a function of macroeconomic uncertainty. Dollarization hysteresis is shown to occur when the expected volatility of the inflation rate is high in relation to that of the real exchange rate. The evidence shows that MVP dollarization generally approximates actual dollarization closely for a broad sample of countries, and policy implications are explored.

Keywords: WP; interest rate; exchange rate; foreign currency; Dollarization; financial intermediation; asset substitution; deposit dollarization; dollarization ratio; loan dollarization; country risk; underlying dollarization; Currencies; Real exchange rates; Loans; Inflation; dollarization hysteresis; MVP dollarization; dollarization trend (search for similar items in EconPapers)
Pages: 48
Date: 1998-03-01
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Citations: View citations in EconPapers (58)

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