A Cross-Country Panel Analysis Of CurrencySubstitution And Trade

This series evidence has been used to analyse the effect of trade on foreign holdings of domesticcurrency. Here we extend a model of currency substitution that incorporates a trade motive forforeigners to hold domestic currency. It uses time series and cross-sectional information for apanel of 17 industrialized countries testing two-way fixed effects models against pooled andrandom-effects alternatives. The cross sectional information is significant, revealing that poolingof data could result in misleading inferences, since country specific effects, regional group effectsand distance are all important determinants of domestic currency holding by foreigners.