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

Author

Listed:
  • Enrique L. Kawamura

    (Department of Economics, Universidad de San Andres)

  • Daniel Heymann

    (ECLAC)

Abstract

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.

Suggested Citation

  • Enrique L. Kawamura & Daniel Heymann, 2005. "On Liability Dollarization: A Simple Model with Domestic and Foreign Creditors," Working Papers 80, Universidad de San Andres, Departamento de Economia, revised Feb 2005.
    • Handle: RePEc:sad:wpaper:80
    as

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    File URL: https://webacademicos.udesa.edu.ar/pub/econ/doc80.pdf
    File Function: First version, 2005
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    References listed on IDEAS

    as
    1. Alain Ize & Andrew Powell, 2003. "Prudential Responses to De Facto Dollarization," Business School Working Papers defactodollarization, Universidad Torcuato Di Tella.
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    5. Roberto Chang & Andres Velasco, 2004. "Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria," CID Working Papers 106, Center for International Development at Harvard University.
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    Cited by:

    1. Roberto Cortes Conde, 2008. "Spanish America Colonial Patterns: The Rio de La Plata," Working Papers 96, Universidad de San Andres, Departamento de Economia, revised Mar 2008.

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