Modeling the Dollarization: A Case Study for Cambodia, Laos, and Vietnam

Abstract

We model the dollarization of three transitional economies in south-east Asia: Cambodia, Laos, and Vietnam which have been experiencing the transition and reform process of the economy for the time period 1992–2007. Based on Rojas-Suarez (IMF Working Paper WP/92/33, 1992) work, we examine whether the holdings of US dollars depend on the effect of the expected rate of depreciation in market exchange rates as expected by the model. Also, we examine whether the effects are proportional to the degree of the dollarization of the economy. The empirical results present that there are positive effects (expected) of the expected rate of depreciation in market exchange rates on the holdings of US dollars. The coefficients are statistically significant only for Cambodia and Laos, not for Vietnam. The effect is strongest for Cambodia, and this may reflect the fact that Cambodia's dollarization is stronger than those of Laos and Vietnam.

Keywords:

• Dollarization
• foreign currency deposits
• expected rate of depreciation in market exchange rates
• Cambodia
• Laos
• Vietnam

Notes

1. For the previous studies, Ortiz (1983) examined the Mexican case, Fasano-Filho (1986) looked at Argentina's case, Ramirez-Rojas (1985) identified the currency substitution in Argentina, Mexico and Uruguay, Canto (1985) studied Dominica's case and El-Erian (1988) checked the presence of currency substitution in Egypt and the Yemen Arab Republic. More recently, Rojas-Suarez (1992) tested dynamic inflation under the presence of currency substitution in the Peruvian economy. Sahay and Végh (1996) discussed currency substitution in transitional economies in Eastern Europe and the states of the former Soviet Union.

2. It is assumed that the utility function is separable in both goods and U(.) is strictly concave. That is, U _H and U _T are positive and diminishing.

3. See Appendix for the proof.

4. The Phillip-Perron unit root test is an alternative method for the ADF test that controls for serial correlation when testing for a unit root. The results are not reported here because the results are not much different from those of the ADF test.

5. ARF is the Lagrange Multiplier (LM) test for serial correlation in residuals. ARCH is the Lagrange Multiplier (LM) test for autoregressive conditional heteroskedasticity (ARCH) in residuals.

6. We do not report other estimation results adding , , …, because the coefficients are not statistically significant.