WHAT IS DRIVING FINANCIAL DOLLARIZATION IN TRANSITION ECONOMIES? A DYNAMIC FACTOR ANALYSIS

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Abstract

This paper investigates the impact of institutions on the dollarization of the domestic banking system using a unique policy experiment: the process of accession of countries to the European Union (EU). Using a dynamic factor model, we decompose fluctuations in financial dollarization for 24 transition economies into a common factor, an EU factor, a non-EU factor, and country-specific factors. The EU factor, which proxies for improvements in institutions under the set criteria for eventual membership, reveals the importance of institutions for the extent of financial dollarization over time. The results also indicate the asymmetric impact of improved institutions on the domestic bank's balance sheets by inducing higher loan dollarization and lower deposit dollarization. The relative importance of the EU factor to the financial dollarization of a country is associated to the degree of comovement of its business cycle with that of the EU. Copyright © Cambridge University Press 2013.

Bibliographical metadata

Original languageEnglish
Pages (from-to)816-835
Number of pages20
JournalMacroeconomic Dynamics
Volume19
Issue number4
Early online date23 Dec 2013
DOIs
Publication statusPublished - 1 Jun 2015

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