Deposit Dollarization as an Investment Signal in Transition Economies : The Cases of Croatia, the Czech Republic, and Slovakia

In highly dollarized banking systems, the high level of foreign currency assets or liabilities on banks' balance sheets may create a currency mismatch risk, which could lead to bank failures when faced with sudden exchange rate movements. Central banks in such economies have to adjust their currency policies accordingly. This paper uses probit and ordered probit models to forecast central banks' direct interventions in the foreign currency markets as a result of exchange rate volatility using data from three transition economies with varying dollarization ratios. We show that, in these three economies, central banks' interventions can be predicted to a degree by measuring dollarization as the ratio of dollar-deposits to M2 monetary base. Investors could potentially use this ratio as an investment signal