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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 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 the opportunity to differentiate themselves from the nonresilient.

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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. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 67(1), pages 91-116, January.
  2. V. V. Chari & Patrick J. Kehoe, 2002. "On the robustness of herds," Working Papers 622, Federal Reserve Bank of Minneapolis.
  3. Jeffrey Sachs & Aaron Tornell & Andres Velasco, 1996. "The Mexican Peso Crisis: Sudden Death or Death Foretold?," NBER Working Papers 5563, National Bureau of Economic Research, Inc.
  4. 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.
  5. Caplin, Andrew & Leahy, John, 1994. "Business as Usual, Market Crashes, and Wisdom after the Fact," American Economic Review, American Economic Association, vol. 84(3), pages 548-65, June.
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  7. Bhattacharya, Sudipto & Detragiache, Enrica, 1994. " The Role of Multilateral Institutions in the Market for Sovereign Debt," Scandinavian Journal of Economics, Wiley Blackwell, vol. 96(4), pages 515-29.
  8. 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.
  9. repec:fth:coluec:602 is not listed on IDEAS
  10. Rogoff, Kenneth & Sibert, Anne, 1988. "Elections and Macroeconomic Policy Cycles," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 55(1), pages 1-16, January.
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  12. Atkeson, Andrew & Rios-Rull, Jose-Victor, 1996. "The balance of payments and borrowing constraints: An alternative view of the Mexican crisis," Journal of International Economics, Elsevier, vol. 41(3-4), pages 331-349, November.
  13. Guillermo A. Calvo, 1995. "Varieties of Capital-Market Crises," Research Department Publications 4008, Inter-American Development Bank, Research Department.
  14. 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.
  15. Graciela Laura Kaminsky, 1999. "Currency and Banking Crises," IMF Working Papers 99/178, International Monetary Fund.
  16. Harold L. Cole & James Dow & William B. English, 1994. "Default, settlement, and signalling: lending resumption in a reputational model of sovereign debt," Staff Report, Federal Reserve Bank of Minneapolis 180, Federal Reserve Bank of Minneapolis.
  17. Gale, D. & Chamley, C., 1992. "Information Revelation and Strategic Delay in a Model of Investment," Papers, Boston University - Department of Economics 10, Boston University - Department of Economics.
  18. Calvo, Guillermo A. & Mendoza, Enrique G., 1996. "Mexico's balance-of-payments crisis: a chronicle of a death foretold," Journal of International Economics, Elsevier, vol. 41(3-4), pages 235-264, November.
  19. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 107(3), pages 797-817, August.
  20. Stephen Morris & Hyun Song Shin, 2000. "Rethinking Multiple Equilibria in Macroeconomic Modelling," Cowles Foundation Discussion Papers 1260, Cowles Foundation for Research in Economics, Yale University.
  21. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  22. 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.
  23. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
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