Exchange Risk, Political Risk, and Investor Demand for External Currency Deposits

Abstract

The growth of the external currency market is an institutional response to the costs and risks that derive from national regulation of financial transactions.l The deposits produced within the external market have combinations of exchange risk attributes and political risk attributes different from those associated with domestic deposits. Investors who acquire external deposits necessarily alter the risk attributes of their portfolios; either the currency in which their deposits are denominated or the country in which deposits are produced is changed. Frequently it is asserted that the growth of the external market has led to a change in the currency mix of investor portfolios and that investors hold a larger share of their portfolios in dollardenominated deposits than they would in the absence of the external market.2 Sometimes it is asserted that the links among national money markets have been tightened as a result of the growth of the market or investors are said to be more willing to alter the currency mix of their portfolios

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