Currency Substitution, Portfolio Diversification, and Money Demand
Miguel Lebre De Freitas
Universidade de Aveiro - Departamento de Economia, Gestão e Engenharia Industrial
Francisco José Veiga
Universidade do Minho and NIPE
Canadian Journal of Economics, Vol. 39, No. 3, pp. 719-743, August 2006
We extend the Thomas (1985) dynamic optimizing model of money demand and currency substitution to the case in which the individual has restricted or no access to foreign currency denominated bonds. In this case currency substitution decisions and asset substitution decisions are not separable. The results obtained suggest that the significance of an expected exchange rate depreciation term in the demand for domestic money provides a valid test for the presence of currency substitution. Applying this approach to six Latin-American countries, we find evidence of currency substitution in Colombia, Dominican Republic, and Venezuela, but not in Brazil and Chile.
Number of Pages in PDF File: 25Accepted Paper Series
Date posted: November 15, 2006
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