Testing the exogeneity of Argentine devaluation and default risks in retrospect

Abstract

This paper studies the relationship between devaluation and default risks during Argentina's convertibility regime. Before default and devaluation occurred, a harder variant of the currency regime was under discussion. An often-suggested argument among the supporters of dollarization was that the probability of default could have been reduced by removing fears of devaluation. For this to be true, default risk must be dependent on the devaluation risk. Long-run relationships and 'exogeneity' are examined using a 'cointegrating vector' system approach. The results show that only devaluation risk can be modelled on default risk. No empirical evidence is found in favour of dollarization. Moreover, these conclusions are maintained when the information set is expanded to include the Latin American risk and Argentine macroeconomic variables. © Blackwell Publishing Ltd, 2005.