Working Paper

Convertibility risk, default risk, and the Mexdollar anomaly

Abstract: Rogers (l992a,b) I put forth the convertibility risk hypothesis in order to explain the anomalous n~gative relationship between the expected rate of Mexican peso depreciation and the ratio of Mexdollars to peso denominated demand deposits. Recently, Gruben and Welch (1994) examine the effect of deteriorating bank loan quality on the variables I consider. Using a cointegration framework, the authors find (i) a negative relationship between non-performing loans and the dollarization ratio and (ii) the conventional positive relationship between expected peso depreciation and dollarization. The first result suggests an additional factor influencing money demand in Mexico. The second result is evidence against my convertibility risk hypothesis. Further analysis indicates that there is some evidence in favor of Gruben and Welch's first result, but that the preponderance of evidence runs counter to their second result.

Keywords: Foreign exchange - Law and legislation; Mexico; Devaluation of currency; Peso, Mexican;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 1995

Number: 495