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Identifying the role of moral hazard in international financial markets

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  • Steven B. Kamin
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    Abstract

    Considerable attention has been paid to the possibility that large-scale IMF-led financing packages may have distorted incentives in international financial markets, leading private investors to provide more credit to emerging market countries, and at lower interest rates, than might otherwise have been the case. Yet, prior attempts to identify such distortions have yielded mixed evidence, at best. This paper makes three contributions to our ability to assess the empirical importance of moral hazard in international financial markets. First, it is argued that because large international "bailouts" did not commence until the 1995 Mexican crisis, financial indicators prior to that time could not have reflected a significant degree of this type of moral hazard. Therefore, one test for the existence of moral hazard is that the access of emerging markets to international credit is significantly easier than it was prior to 1995. Second, the paper argues that because private investors expect large-scale IMF-led packages to be extended primarily to economically or geo-politically important countries, moral hazard, if it exists, should lead these countries to have easier terms of access to credit than smaller, non-systemically important countries. Finally, in addition to looking at bond spreads, the focus of earlier empirical analyses of moral hazard, the paper also examines trends in capital flows to gauge the access of emerging market countries to external finance. Looking at the evidence in light of these considerations, the paper concludes that there is little support for the view that moral hazard is significantly distorting international capital markets at the present time.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 736.

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    Date of creation: 2002
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    Handle: RePEc:fip:fedgif:736

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    Keywords: Financial markets ; Developing countries;

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    References

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    1. Richard Cantor & Frank Packer, 1996. "Determinants and impacts of sovereign credit ratings," Research Paper 9608, Federal Reserve Bank of New York.
    2. Hong G. Min, 1998. "Determinants of emerging market bond spread : do economic fundamentals matter?," Policy Research Working Paper Series 1899, The World Bank.
    3. Fernandez-Arias, Eduardo & DEC, 1994. "The new wave of private capital inflows : push or pull?," Policy Research Working Paper Series 1312, The World Bank.
    4. Steven Phillips & Timothy D. Lane, 2000. "Does IMF Financing Result in Moral Hazard?," IMF Working Papers 00/168, International Monetary Fund.
    5. Montiel, Peter & Reinhart, Carmen M., 1999. "Do capital controls and macroeconomic policies influence the volume and composition of capital flows? Evidence from the 1990s," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 619-635, August.
    6. Giovanni Dell'Ariccia & Jeromin Zettelmeyer & Isabel Schnabel, 2002. "Moral Hazard and International Crisis Lending: A Test," IMF Working Papers 02/181, International Monetary Fund.
    7. Leonardo Leiderman & Carmen Reinhart & Guillermo Calvo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America," IMF Working Papers 92/62, International Monetary Fund.
    8. Andy Haldane & Mark Kruger, 2001. "The Resolution of International Financial Crises: Private Finance and Public Funds," Working Papers 01-20, Bank of Canada.
    9. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
    10. Eichengreen, Barry & Mody, Ashoka, 1998. "Interest Rates in the North and Capital Flows to the South: Is There a Missing Link?," International Finance, Wiley Blackwell, vol. 1(1), pages 35-57, October.
    11. Chuhan, Punam & Claessens, Stijn & Mamingi, Nlandu, 1998. "Equity and bond flows to Latin America and Asia: the role of global and country factors," Journal of Development Economics, Elsevier, vol. 55(2), pages 439-463, April.
    12. Olivier Jeanne & Jeromin Zettelmeyer, 2001. "International bailouts, moral hazard and conditionality," Economic Policy, CEPR & CES & MSH, vol. 16(33), pages 407-432, October.
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    Cited by:
    1. Schröder, Michael & Heinemann, Friedrich & Kruse, Susanne & Meitner, Matthias, 2004. "GPD-linked Bonds as a Financing Tool for Developing Countries and Emerging Markets," ZEW Discussion Papers 04-64, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    2. Dani Rodrik, 2006. "The social cost of foreign exchange reserves," International Economic Journal, Taylor & Francis Journals, vol. 20(3), pages 253-266.
    3. Michael Schröder & Friedrich Heinemann & Susanne Kruse & Matthias Meitner, 2007. "Pay high in good times, pay low in bad times," Journal of International Development, John Wiley & Sons, Ltd., vol. 19(5), pages 667-683.
    4. Tillmann, Peter, 2005. "Private sector involvement in the resolution of financial crises: How do markets react?," Journal of Development Economics, Elsevier, vol. 78(1), pages 114-132, October.
    5. Jun Il Kim, 2007. "Unconditional IMF Financial Support and Investor Moral Hazard," IMF Working Papers 07/104, International Monetary Fund.
    6. Evrensel, Ayşe Y. & Kutan, Ali M., 2004. "Testing creditor moral hazard in sovereign bond markets: A unified theoretical approach and empirical evidence," ZEI Working Papers B 09-2004, ZEI - Center for European Integration Studies, University of Bonn.
    7. Montes, Gabriel Caldas & Tiberto, Bruno Pires, 2012. "Macroeconomic environment, country risk and stock market performance: Evidence for Brazil," Economic Modelling, Elsevier, vol. 29(5), pages 1666-1678.
    8. Ilan Noy, 2004. "Do IMF Bailouts Result in Moral Hazard? An Events-Study Approach," Working Papers 200402, University of Hawaii at Manoa, Department of Economics.
    9. Jong-Wha Lee & Kwanho Shin, 2005. "IMF Bailouts and Moral Hazard," International Finance 0501005, EconWPA.
    10. Marcel Fratzscher & Julien Reynaud, 2010. "IMF Surveillance and Financial Markets - A Political Economy Analysis," CESifo Working Paper Series 3089, CESifo Group Munich.
    11. Andrew G Haldane & Jorg Scheibe, 2004. "IMF lending and creditor moral hazard," Bank of England working papers 216, Bank of England.
    12. Edda Zoli, 2004. "Credit Rationing in Emerging Economies' Access to Global Capital Markets," IMF Working Papers 04/70, International Monetary Fund.
    13. Noy, Ilan, 2008. "Sovereign default risk, the IMF and creditor moral hazard," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 18(1), pages 64-78, February.
    14. Olivier Jeanne & Jeromin Zettelmeyer, 2004. "The Mussa Theorem," IMF Working Papers 04/192, International Monetary Fund.

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