• E4;
  • E5;
  • F3;
  • financial dollarization;
  • inflation targeting;
  • portfolio model;
  • treatment effect;
  • propensity score matching

We examine whether adopting an inflation-targeting regime helps reduce financial dollarization as predicted by Ize and Levy Yeyati's (2003) portfolio model. To address the self-selection problem of policy adoption, we apply a variety of propensity score matching methods to a large sample of 106 developing countries for the years 1985–2004. We find strong evidence that inflation targeting has large and significant treatment effects on lowering both actual financial dollarization and the model implied minimum variance portfolio dollarization. Our results are robust to alternative samples and model specifications and also to control for additional factors in postmatching regressions.