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Quid pro Quo: National Institutions and Sudden Stops in International Capital Movements

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  • Eduardo A. Cavallo
  • Andrés Velasco

Abstract

The paper explores the incidence of sudden stops in capital flows on the incentives for building national institutions that secure property rights in a world where sovereign defaults are possible equilibrium outcomes. Also the paper builds upon the benchmark model of sovereign default and direct creditor sanctions by Obstfeld and Rogoff (1996). In their model it is in the debtor countrys interest to tie its hands and secure the property rights of lenders as much as possible because this enhances the credibility of the countrys romise to repay and prevents default altogether. It incorporate two key features of todays international financial markets that are absent from the benchmark model: the possibility that lenders can trigger sudden stops in capital movements, and debt contracts in which lenders transfer resources to the country at the start of the period, which have to be repaid later. The paper shows that under these conditions the advice build institutions to secure repayment at all costs may be very bad advice indeed.

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Bibliographic Info

Paper provided by Inter-American Development Bank in its series IDB Publications with number 6711.

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Date of creation: Nov 2006
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Handle: RePEc:idb:brikps:6711

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Keywords: Financial Sector; WP-587;

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  1. Guillermo A. Calvo & Alejandro Izquierdo & Luis-Fernando Mejia, 2004. "On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects," NBER Working Papers, National Bureau of Economic Research, Inc 10520, National Bureau of Economic Research, Inc.
  2. Frankel, Jeffrey & Cavallo, Eduardo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality," Working Paper Series, Harvard University, John F. Kennedy School of Government rwp04-038, Harvard University, John F. Kennedy School of Government.
  3. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, American Economic Association, vol. 88(3), pages 587-97, June.
  4. Guillermo A. Calvo & Alejandro Izquierdo & Ernesto Talvi, 2003. "Sudden Stops, the Real Exchange Rate, and Fiscal Sustainability: Argentina's Lessons," NBER Working Papers, National Bureau of Economic Research, Inc 9828, National Bureau of Economic Research, Inc.
  5. Brian D. Wright & Kenneth M. Kletzer, 2000. "Sovereign Debt as Intertemporal Barter," American Economic Review, American Economic Association, American Economic Association, vol. 90(3), pages 621-639, June.
  6. Rudger Dornbusch & Ilan Goldfajn & Rodrigo O. Valdés, 1995. "Currency Crises and Collapses," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 219-294.
  7. Sebastian Edwards, 2004. "Financial Openness, Sudden Stops and Current Account Reversals," NBER Working Papers, National Bureau of Economic Research, Inc 10277, National Bureau of Economic Research, Inc.
  8. Eduardo A. Cavallo, 2005. "Trade, gravity, and sudden stops: on how commercial trade can increase the stability of capital flows," Working Paper, Federal Reserve Bank of Atlanta 2005-23, Federal Reserve Bank of Atlanta.
  9. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, Universidad del CEMA, vol. 0, pages 35-54, November.
  10. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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