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  • V. V. Chari
  • Patrick J. Kehoe

Abstract

Recent empirical work on financial crises documents that crises tend to occur when macroeconomic fundamentals are weak, but that even after conditioning on an exhaustive list of fundamentals, a sizable random component to crises and associated capital flows remains. We develop a model of herd behavior consistent with these observations. Informational frictions together with standard debt default problems lead to volatile capital flows resembling hot money and financial crises. We show that repaying debt during difficult times identifies a government as financially resilient, enhances its reputation and stabilizes capital flows. Bailing out governments deprives resilient countries of this opportunity.

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Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 506439000000000415.

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Date of creation: 14 Mar 2003
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Handle: RePEc:cla:levrem:506439000000000415

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  1. repec:fth:coluec:602 is not listed on IDEAS
  2. V. V. Chari & Patrick J. Kehoe, 2002. "On the robustness of herds," Working Papers, Federal Reserve Bank of Minneapolis 622, Federal Reserve Bank of Minneapolis.
  3. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
  4. Cole, Harold L & Dow, James & English, William B, 1995. "Default, Settlement, and Signalling: Lending Resumption in a Reputational Model of Sovereign Debt," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(2), pages 365-85, May.
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  8. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 35-54, November.
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  15. Stephen Morris & Hyun Song Shin, 2001. "Rethinking Multiple Equilibria in Macroeconomic Modeling," NBER Chapters, in: NBER Macroeconomics Annual 2000, Volume 15, pages 139-182 National Bureau of Economic Research, Inc.
  16. Andrew Atkeson & Jose-Victor Rios-Rull, 1995. "The Balance of Payments and Borrowing Constraints: An Alternative View of the Mexican Crisis," NBER Working Papers 5329, National Bureau of Economic Research, Inc.
  17. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," Working Paper, Federal Reserve Bank of Atlanta 98-10, Federal Reserve Bank of Atlanta.
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  21. Roberto Chang & Andrés Velasco, 2001. "A Model Of Financial Crises In Emerging Markets," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 116(2), pages 489-517, May.
  22. Reinhart, Carmen & Goldstein, Morris & Kaminsky, Graciela, 2000. "Assessing financial vulnerability, an early warning system for emerging markets: Introduction," MPRA Paper 13629, University Library of Munich, Germany.
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