Foreign currency debt has led to many crises in emerging markets. In the past decade, firms in emerging economies have drastically increased their foreign currency borrowing, making them significantly exposed to depreciation shocks. To reduce their exposure to external shocks, central banks have increased their use of regulation, such as imposing capital controls. However, the effectiveness of such policies is still unclear. Moreover, very little is known about how are firms using the derivatives markets to hedge the risk of increasing their foreign currency liabilities. In this dissertation, presents empirical evidence and a model that shows a new side effect of capital controls: Capital controls can increase firms’ exposure to the exchange rate. In particular, I study whether capital controls can have the unintended consequence of inducing domestic banks to lend more in foreign currency to domestic firms. I exploit heterogeneity in the strictness of capital controls across Peruvian banks to provide novel causal evidence of the effect of capital controls on banks lending to local firms. Using a unique dataset that includes all foreign exchange transactions and loans given by Peruvian banks, I find that capital controls encourage firms to take more foreign currency loans. I describe a new mechanism and present a model to explain these findings, in which capital controls induce local banks to shift exchange rate exposure away from foreigners and onto domestic firms. This is worrisome as the literature shows that depreciation shocks have led to significant reductions in investment and employment for these firms.

Creator

• Keller, Lorena

DOI

• https://doi.org/10.21985/n2-2h79-dv14

Subject

• Finance

Language

• en

Alternate Identifier

• http://dissertations.umi.com/northwestern:14972
• etdadmin_upload_715245

Date created

• 2020-01-01

Resource type

• Dissertation

Rights statement

• In Copyright