1. ¹Monetary Department, Bank of Israel, PO Box 780, Jerusalem 91007, Israel. E-mail: akoffen@bankisrael.gov.il
2. ²Monetary Department, Bank of Israel, PO Box 1604, Tel Aviv 61015, Israel. E-mail: roy_s@boi.gov.il

Abstract

The currency substitution and indexation infrastructure that has prevailed in Israel for over five decades had its inception before the onset of a major inflationary episode and included only minor and short-lived incidents of outright dollarisation. The present paper suggests that portfolio allocation models, based on the return-risk trade-off, provide a better understanding of these distinctive features of the Israeli financial scene than more conventional approaches to currency substitution based on money demand models. Some indicative results and policy implications from estimated equations based on the CAPM are presented.