Alternative Measures of Currency and Asset Substitution: The Case of Turkey

Abstract

This paper attempts to develop theoretically consistent distinct measures of asset and currency substitution, taking into account the different degrees of liquidity provided by alternative monetary assets. The measures are then calculated for the case of Turkey and the relevance of the asset and currency substitution hypotheses as well as the hysteresis hypothesis are tested in a cointegrated VAR framework. Empirical results suggest a long run relation between the domestic-foreign inflation differential and the currency substitution ratio as well as a long run relation between the gross rate of return on foreign currency deposits and the asset substitution ratio. There is also evidence of a positive long run relation between the gross rate of return on T-Bills and the asset substitution ratio. Finally although there is no econometric evidence of irreversibility in asset substitution, the rate of depreciation of YTL is found to be a significant ratchet for currency substitution.