Temporary Stabilization and the Real Option of Waiting when Consumption can be Delayed: an Extreme Value Approach
AbstractThis paper develops, in a small open economy framework, a stochastic model of exchange-rate-based inflation stabilization that is expected to be temporary. Agents have expectations of devaluation driven by a mixed diffusion-jump process where the expected size of a possible devaluation is supposed to have an extreme value distribution of the Fréchet type; as the stylized facts from the Mexican's 1994 and Argentinean's 2001 cases have show n. Consumption and wealth equilibrium dynamics are examined when a stabilization plan is implemented. The case of a stochastic stabilization horizon guided by an exponential distribution is studied. Moreover, this paper also deals with pricing the real option of waiting for postponing consumption when a stabilization plan is about to be abandoned; a claim on a non-traded asset. We also assess the effects of exogenous shocks on consumption and economic welfare. Finally, we use the proposed model to carry out simulation experiments that reproduces the booms of private consumption in the Mexican case of 1989-1994 and the Argentinean case of 2001-2003, which resulted in extreme devaluations.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by DEGIT, Dynamics, Economic Growth, and International Trade in its series DEGIT Conference Papers with number c010_043.
Length: 28 pages
Date of creation: Jun 2005
Date of revision:
Inflation stabilization; Contingent claims; Extreme values;
Find related papers by JEL classification:
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-12-01 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Francisco Venegas-Martínez, 2000. "On Consumption, Investment and Risk," Economia Mexicana NUEVA EPOCA, , vol. 0(2), pages 227-244, July-Dece.
- Francisco Venegas Martínez, 2005. "Política fiscal, estabilización de precios y mercado incompletos," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 20(1), pages 3-25.
- Guillermo A. Calvo & Allan Drazen, 1997. "Uncertain Duration of Reform: Dynamic Implications," NBER Working Papers 5925, National Bureau of Economic Research, Inc.
- Rebelo, Sérgio, 1995.
"Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories,"
CEPR Discussion Papers
1220, C.E.P.R. Discussion Papers.
- Sergio Rebelo & Carlos A. Vegh, 1995. "Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 125-188 National Bureau of Economic Research, Inc.
- Rebelo, S. & Vegh, C.A., 1995. "Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories," RCER Working Papers 405, University of Rochester - Center for Economic Research (RCER).
- Sergio Rebelo & Carlos A. Vegh, 1995. "Real Effects of Exchange Rate-Based Stabilization: An Analysis of Competing Theories," NBER Working Papers 5197, National Bureau of Economic Research, Inc.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Venegas-Martinez, Francisco, 2001. "Temporary stabilization: A stochastic analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 25(9), pages 1429-1449, September.
- Mendoza, Enrique & Uribe, Martin, 1997.
"The Syndrome of Exchange-Rate-Based Stabilizations and the Uncertain Duration of Currency Pegs,"
97-30, Duke University, Department of Economics.
- Enrique G. Mendoza & Martin Uribe, 1997. "The syndrome of exchange-rate-based stabilizations and the uncertain duration of currency pegs," Discussion Paper / Institute for Empirical Macroeconomics 121, Federal Reserve Bank of Minneapolis.
- Enrique G. Mendoza & Martin Uribe, 1996. "The syndrome of exchange-rate-based stabilizations and the uncertain duration of currency pegs," International Finance Discussion Papers 548, Board of Governors of the Federal Reserve System (U.S.).
- Uribe, Martin, 1997.
"Exchange-rate-based inflation stabilization: The initial real effects of credible plans,"
Journal of Monetary Economics,
Elsevier, vol. 39(2), pages 197-221, July.
- Martin Uribe, 1995. "Exchange-rate based inflation stabilization: the initial real effects of credible plans," International Finance Discussion Papers 503, Board of Governors of the Federal Reserve System (U.S.).
- Frank Strobel, 2004.
"Monetary integration and inflation preferences: a real options analysis,"
Money Macro and Finance (MMF) Research Group Conference 2003
95, Money Macro and Finance Research Group.
- Strobel, Frank, 2005. "Monetary integration and inflation preferences: A real options analysis," European Economic Review, Elsevier, vol. 49(4), pages 845-860, May.
- Venegas-Martinez, Francisco, 2006. "Stochastic temporary stabilization: Undiversifiable devaluation and income risks," Economic Modelling, Elsevier, vol. 23(1), pages 157-173, January.
- Venegas Martínez, Francisco & Fundia Aizenstat, Andrés, 2006. "Opciones reales, valuación financiera de proyectos y estrategias de negocios. Aplicaciones al caso mexicano," El Trimestre Económico, Fondo de Cultura Económica, vol. 0(290), pages 363-405, abril-jun.
- Drazen, Allan & Helpman, Elhanan, 1987. "Stabilization with Exchange Rate Management," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 835-55, November.
- Enrique G. Mendoza & Martin Uribe, 1998. "The business cycles of currency speculation: a revision of the Mundellian framework," International Finance Discussion Papers 617, Board of Governors of the Federal Reserve System (U.S.).
- Henderson, Vicky & Hobson, David G., 2002. "Real options with constant relative risk aversion," Journal of Economic Dynamics and Control, Elsevier, vol. 27(2), pages 329-355, December.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michaela Rank).
If references are entirely missing, you can add them using this form.