Testing of Currency Substitution Effect on Exchange Rate Volatility in Serbia
Abstract
Despite numerous different definitions existing in the literature, currency substitution is generally understood as a phenomenon when domestic residents prefer to use foreign currency rather than domestic currency. The main reasons for such phenomenon include high and volatile inflation, strong depreciation of national currency and high interest rate differential in favour of foreign currency. Currency substitution, as a monetary phenomenon, is widely spread in Latin American, Eastern European and some Asian countries. This paper is dedicated to the influence of currency substitution on exchange rate volatility in Serbia. The research included testing of three hypotheses: (i) currency substitution positively affects depreciation rate volatility, (ii) depreciation rate volatility has stronger responses to the past negative than to the past positive depreciation shocks, and (iii) currency substitution positively affects expected depreciation rate. The analysis was implemented for the period 2002:m1-2015:m12 (2004:m1-2015:m12), applying modified EGARCH-M model. Based on the obtained results, all three hypotheses have been supremely rejected regardless of the manner of quantification of currency substitution.
References
Akçay, O.C., Alper, C.E., & Karasulu, M. (1997). Currency substitution and exchange rate instability: The Turkish case. European Economic Review, 41, 827-835.
Calvo, G.A., & Vegh, C.A. (1992). Currency substitution in developing countries: An introduction. Revista de Análisis Económico, 7(1), 3-27.
Canzoneri, M.B., & Diba, B.T. (1993). Currency substitution and exchange rate volatility in the European Community. Journal of International Economics, 35(3-4), 351-365.
Cuddington, J., Garcia, R.M., & Westbrook, D. (2002). A micro-foundations model of dollarization with network externalities and portfolio choice: The case of Bolivia. Retrieved from http://inside.mines.edu/∼jcudding/papers/Currency_Substitution/CGW_CS.pdf
Girton, L., & Roper, D. (1981). Theory and implications of currency substitution. Journal of Money, Credit, and Banking, 13(1), 12-30.
Isaac, A.G. (1989). Exchange rate volatility and currency substitution. Journal of International Money and Finance, 8(2), 277-284.
Kareken, J., & Wallace, N. (1981). On the indeterminacy of equilibrium exchange rates. Quarterly Journal of Economics, 96(2), 207-222.
Khan, M.S., & Ramirez-Rojas, C.L. (1986). Currency substitution and government revenue from inflation. Análisis Económico, 1(1), 79-88.
Kumamoto, H., & Kumamoto, M. (2008). Currency substitution, network externalities and hysteresis effects. Journal of Commerce, Economics and Economic History, 77(1), 1-13.
Kumamoto, H., & Kumamoto, M. (2014). Does currency substitution affect exchange rate volatility?. International Journal of Economics and Financial Issues, 4(4), 698-704.
Kumamoto, H. (2014). Recent Experiences with Currency Substitution. International Journal of Financial Research, 5(4), Retrieved from http://www.sciedu.ca/journal/index.php/ijfr/article/view/5406/3197
Mahdavi, M., & Kazemi, H.B. (1996). Indeterminacy and volatility of exchange rates under imperfect currency substitution. Economic Inquiry, 34(1), 168-181.
Mckinnon, R.I. (1985). Two concepts of international currency substitution. In M.D. Connoly & J. McDermott (Eds.), The economics of the Caribbean Basin. (pp. 101-113). New York: Praeger.
Milenković, I., & Davidović, M. (2013). Determinants of Currency Substitution/Dollarization - The Case of the Republic of Serbia. Journal of Central Banking Theory and Practice, 139-155.
Lee, S.R. (2010). Is There Currency Substitution in Korea?. International Area Studies Review, 13, 243-249.
Nelson, D.B. (1991). Conditional heteroskedasticity in asset returns: A new approach. Econometrica, 59(2), 347-370.
Oomes, N. (2003). Network externalities and dollarization hysteries: The case of Russia. IMF Working paper, Retrieved from https://www.imf.org/external/pubs/ft/wp/2003/wp0396.pdf
Özbilgin, H.M. (2012). Currency substitution, inflation, and welfare. Journal of Development Economics, 99(2), 358-369.
Petrović, P. (2013). Testing of real exchange rate: Real interest rate differential relationship in Serbia: EMU case. Industrija, 41(4), 111-125.
Saatçíoğlu, C., Bulut, C., & Korap, L. (2007). Does currency substitution affect exchange rate uncertainty?, The case of Turkey. MPRA Paper, 20319,
Samreth, S. (2011). An empirical study on the hysteresis of currency substitution in Cambodia. Journal of Asian Economics, 22(6), 518-527.
Stix, H. (2011). Euroization: What factors drive its persistence?, Household data evidence for Croatia, Slovenia and Slovakia. Applied Economics, 43(21), 2689-2704.
Šoškić, D. (2015). EU banking union: Lessons for non-eurozone transition countries. Industrija, 43(2), 164-181.
Tsay, R.S. (2010). Analysis of Financial Time Series. Chicago, IL: John Wiley & Sons..
Yinusa, D.O. (2008). Between dollarization and exchange rate volatility: Nigeria's portfolio diversification option. Journal of Policy Modeling, 30(5), 811-826.
Valev, T.N. (2010). The hysteresis of currency substitution: Currency risk vs. network externalities. Journal of International Money and Finance, 29(2), 224-235.
Xaiyavong, I., & Toyoda, T. (2016). Currency Substitution in Laos. Asian Economic Journal, 30(1), 67-89.