We empirically investigate recent experiences with currency substitution. We focus especially on the determinants of currency substitution, namely, the factors representing the usefulness of a foreign currency both as a medium of exchange and a store of value. This paper has three key distinguishing features. First, our sample includes eight developing and/or emerging countries from different regions to permit direct cross-country comparison, unlike in many previous studies. Second, this study

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... overs a recent sample period. The U.S. dollar and the euro have been depreciating against other currencies since the 2007 financial crisis, and have therefore become less useful as a store of value. Therefore, it is important that we investigate whether the determinants of currency substitution have changed in recent periods. Third, we derive an estimated equation from the agent's utility maximization problem. In particular, we introduce the exchange rate risk premium as an alternative determinant, considering its relevance to the forward premium puzzle-the failure of the interest rate differential to correctly represent expected changes in the nominal exchange rate and hence the usefulness of foreign currency as a store of value. The empirical results indicate that the variables representing the usefulness of foreign currency both as a medium of exchange and a store of value are significant determinants of currency substitution. The results show that currency substitution has important monetary policy implications. Many previous studies have investigated currency substitution. (Note 3) However, most of them considered a single country or a few countries within the same region, making comparative studies among countries and regions impossible. Furthermore, they focused on sample periods characterized by macroeconomic destabilization (high inflation, expansion of the interest rate differential, and depreciation of the domestic currency vis-à-vis the U.S. (2) γ>0, 0<δ(·)<1, δ(1)=1/2, δ'(·)>0, ε>-1, C t is real consumption, M t and M t * are nominal balances of domestic and foreign currencies, respectively, and P t and P t * are the domestic and foreign price levels, respectively. K t is the domestic residents' average accumulated knowledge and experience of using foreign currency, which is a proxy for the general acceptability of foreign currency as a medium of exchange. We suppose that households take K t as given, but at an aggregate level, K t is endogenously determined. β is a subjective discount factor. B t and B t * are nominal bonds denominated in domestic and foreign currencies, respectively. i t-1 and i t-1 * are nominal interest rates on bonds issued at the end of period t -1 to the end of period t. Y t is real income determined exogenously. Our utility function is specified as follows: (1) a household's preference can be represented by an additive separable function with respect to real consumption C t and currency index X t , (2) the currency index X t is a constant elasticity of substitution (CES) technology in which elasticity of substitution is equal to 1/(1+ε), and (3) the share of foreign currency in the utility function, δ, is an increasing function of K t , because foreign currency become more attractive as a medium of exchange as K t increases.