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This dissertation is composed of three essays that study the role of key financial instruments and new financial technologies in investment and policy decisions.In the first essay, I investigate convenience yields, which are non-pecuniary benefits in the form of liquidity, of portfolio debt assets or safe assets for emerging market economies (EMEs). Along with the United States, the Euro area, the United Kingdom, and Japan act as the major safe asset providers to an EME. Empirically, I establish that convenience yield of various safe assets differs for an EME investor, convenience yield of a particular safe asset varies during different time periods, convenience yield plays a crucial role in explaining covered interest parity deviations, and forecasts of the convenience yield for various safe asset providers are dissimilar. I develop a simple safe assets portfolio model for an EME investor that helps to understand their investment behavior. The framework predicts a positive relationship between the convenience yield and the share of the safe assets, and it is validated empirically for the United States, the Euro area, and Japan safe assets in an EME investor portfolio. I demonstrated through structural estimation that convenience yield is the second-most significant channel in explaining the interest rate differentials between an EME and a safe asset provider.The second essay is co-authored with Eswar Prasad. We explore the implications of adoption of the Central Bank Digital Currency (CBDC) in an economy. CBDC is electronic, universally accepted, and central bank issued money. We present a general equilibrium model that highlights the economic trade-offs between cash and CBDC. The key differences between cash and CBDC include transaction efficiency, possibilities for tax evasion, and, potentially, nominal rates of return. We examine the differential sensitivity of the CBDC share to changes in different parameters. Our model suggests that the highest degree of sensitivity of the CBDC share is due to the nominal rate of return on CBDC. We also evaluate the welfare implications of different settings of the policy parameters. Increases in the transaction efficiency and rate of return on CBDC generate welfare gains. We establish conditions under which cash and CBDC can co-exist and show how government policies can influence relative holdings of cash, CBDC, and other assets. We also illustrate how a CBDC can facilitate negative nominal interest rates and helicopter drops, and how a CBDC can be structured to prevent capital flight from other assets.In the third essay, I document a direct benefit of circulation of CBDC. A quantitative model is developed to understand the effects of the introduction of CBDC on tax evasion and the relative sizes of formal and informal economies. This paper proposes the conditions under which CBDC helps in reducing the amount of tax evasion in an economy. Monitoring and detecting the process of tax evasion in an economy is a costly business. Introduction of CBDC leads to reduction in monitoring cost which enhances the probability of detection of tax evaders. Eventually, this mechanism results in lower level of tax evasion in the economy. The agent faces a penalty cost when detected for tax evasion. CBDC increases transparency and induces higher penalty cost. This theory suggests an agent is motivated to move towards high penalty cost CBDC regime due to low tax rate.
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