Essays on money and asset prices

The first chapter reviews the vast literature on currency substitution. We first observe that "currency substitution" is an imprecise concept, and therefore begin by proposing the distinction between currency substitutability--the ability and willingness of economic agents to satisfy their needs for a unit of account, medium of exchange and store of value with different currencies--and currency substitution--the equilibrium outcome of the process in which one currency replaces another. This distinction is useful since the theoretical and empirical literature often fails to recognize that one does not expect either one to imply the other. Data problems preventing a useful measurement of currency substitution are discussed and the available evidence is reviewed. This chapter also reviews the very large empirical literature attempting to estimate currency substitutability, by highlighting the problems of interpretation in the models that have been estimated. Finally, it considers the policy problems stemming from currency substitution and the ensuing instability of monetary aggregates.; The second chapter incorporates these currency substitution effects in a two-country general-equilibrium asset pricing model. As is documented extensively in chapter one, increased currency substitution leads to a higher instability of exchange rates and interest rates. This chapter addresses this issue from an empirical angle. Rather than estimating reduced form portfolio equations, we simulate a two-country cash-in-advance economy. However, we apply the cash-in-advance constraint only to a subset of goods in each country and allow for the rest to be paid with credit in either currency. This approach captures the institutional aspects of currency substitution nicely and puts an upper bound to the degree of currency substitution. Simulation results for two pairs of countries--United States-United Kingdom and United Kingdom-France--show that this avenue is fruitful in tracking exchange rate moments observed in these countries and substantially improves upon the standard model.; The third chapter motivates money demand through the need to pay taxes with legal tender. One of the reasons why people hold money is that they are compelled to do so by governments. This chapter explores a model where money demand arises from the legal requirement to settle transactions with the government in cash. As an illustration, we simulate the model for Brazil during 1975-1992. We compare the performance of the model to generate the observed volatility in consumption velocity during 1975-86 (relatively low inflation) and 1987-1992 (the high-inflation years), and show that it differs substantially in the two subperiods.