Dollarization As An Investment Signal In Developing Countries

In dollarized financial systems, there exists a currency mismatch risk that could lead to financial crises. Central Banks in such economies have to adjust their foreign currency policies accordingly. This paper estimates the probability of Central Bankers' intervention in the foreign currency markets in dollarized economies as explained by the volatility measures of the local exchange rate. By employing data from five countries, the author shows that in controlled inflation environments, not only Central Banks' interventions but also the direction of the interventions can be predicted to a good degree while under high inflation the model fails to provide healthy results.