Essays on International Finance and Economics

The first essay explains why credit contracts in developing countries are often denominated in foreign currencies, even after many of these economies succeeded in controlling inflation. I propose a new interpretation based on the demand for insurance against real aggregate shocks. The fact that devaluations occur more frequently in adverse states of the world provides a motive for holding dollar assets when the risk of recession is the main source of volatility in consumption. The model predicts persistence in the degree of "dollarization" in economies with low inflationary risk. The second essay looks at how the government's lack of commitment technology affects the capacity of resident agents to optimally diversify risk. I find that government's moral hazard introduces a trade-off between pooling idiosyncratic risk and diversifying aggregate country uncertainty. As a result, local agents face excessive consumption risk. This paper also explores how institutions can be designed as to overcome this moral hazard problem. The third essay proposes an explanation for the variation across countries in the quality of the institutions governing the financial. The explanation based on the proportion of local investors participating in the domestic financial sector. I find that the participation of local investors in the financial market and, correspondingly, the resulting institutions vary according to wealth distribution and the size of capital inflows. Thesis Supervisor: Daron Acemoglu Title: Charles P. Kindleberger Professor of Applied Economics Thesis Supervisor: Olivier Blanchard Title: Class of 1941 Professor, Macroeconomics Thesis Supervisor: Ricardo Caballero Title: Ford International Professor of Economics, Macroeconomics and International Finance