Convertibility risk and dollarization in Mexico: a vectorautoregressive analysis

Abstract

Using a general equilibrium model of dollarization in Mexico, I find a negative and significant relationship between the expected rate of peso depreciation and the dollarization ratio. This result, seemingly anomalous compared to previous studies of currency substitution, is attributed to the convertibility risk associated with holding Mexdollars. Several alternative explanations are either rejected or found to be of secondary importance. The results imply that traditional methodologies used to test currency substitution and inferences drawn about the phenomenon should be revised in cases similar to Mexico. © 1992.