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Contagion of Financial Crises in Sovereing Debt Markets

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  • Sandra Lizarazo

    ()
    (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM))

Abstract

This paper develops a quantitative model of debt, default, and contagion of financial crises for small open economies that interact with risk averse international investors. The paper extends the recent literature on endogenous default risk to the case in which several emerging economies that cannot credibly commit to honor their international debts have common investors. The existence of common investors with preferences that exhibit decreasing absolute risk aversion generates financial links between the emerging economies sovereign debt markets that help to explain the endogenous determination of credit limits, capital flows, and the risk premium in sovereign bond prices as function not only of the economy's fundamentals, the investors' characteristics (wealth, and degree of risk aversion) but more importantly of the fundamentals of other emerging economies. Therefore this paper provides a theoretical formalization that is the base for and endogenous explanation of the contagion of financial crises.

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Bibliographic Info

Paper provided by Centro de Investigacion Economica, ITAM in its series Working Papers with number 0906.

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Length: 65 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:cie:wpaper:0906

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Keywords: Contagion; Sovereign Debt; Financial Links; Default;

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  1. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
  2. Jafarey, Saqib & Rupert, Peter, 2001. "Limited Commitment, Money, and Credit," Journal of Economic Theory, Elsevier, vol. 99(1-2), pages 22-58, July.
  3. International Monetary Fund, 1999. "Sources of Contagion," IMF Working Papers 99/146, International Monetary Fund.
  4. Sandra Lizarazo & Jose Maria Da-Rocha, 2009. "Money, Credit and Default," Working Papers 0908, Centro de Investigacion Economica, ITAM.
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  8. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2009. "Heterogeneous Borrowers In Quantitative Models Of Sovereign Default," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 50(4), pages 1129-1151, November.
  9. Xinshen Diao & Wenli Li & Erinc Yeldan, 2000. "How the Asian crisis affected the world economy : a general equilibrium perspective," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 35-59.
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Citations

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Cited by:
  1. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2008. "Heterogeneous borrowers in quantitative models of sovereign default," Working Paper 07-01, Federal Reserve Bank of Richmond.
  2. Leonardo Martinez & Cesar Sosa Padilla & Juan Hatchondo, 2012. "Debt dilution and sovereign default risk," 2012 Meeting Papers 974, Society for Economic Dynamics.
  3. Leonardo Martinez & Juan Carlos Hatchondo, 2009. "A model of credit risk without commitment," 2009 Meeting Papers 978, Society for Economic Dynamics.
  4. Juan Carlos Hatchondo & Francisco Roch & Leonardo Martinez, 2012. "Fiscal Rules and the Sovereign Default Premium," IMF Working Papers 12/30, International Monetary Fund.
  5. Ludwig, Maximilian, 2013. "Government Debt and Default in a Minimal State," Working Papers 30/2013, Universidade Portucalense, Centro de Investigação em Gestão e Economia (CIGE).
  6. Cristina Arellano & Yan Bai, 2013. "Linkages across Sovereign Debt Markets," NBER Working Papers 19548, National Bureau of Economic Research, Inc.
  7. Lizarazo, Sandra, 2010. "Default Risk and Risk Averse International Investors," MPRA Paper 20794, University Library of Munich, Germany.
  8. Leonardo Martinez & Juan Hatchondo & Javier Bianchi, 2012. "Sovereign defaults and optimal reserves management," 2012 Meeting Papers 1125, Society for Economic Dynamics.
  9. Cristina Arellano & Yan Bai, 2013. "Linkages across sovereign debt markets," Staff Report 491, Federal Reserve Bank of Minneapolis.
  10. Juan Carlos Hatchondo & Cesar Sosa-Padilla & Leonardo Martinez, 2010. "Debt dilution, overborrowing, and sovereign default risk," 2010 Meeting Papers 481, Society for Economic Dynamics.

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