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Are Asset Price Guarantees Useful for Preventing Sudden Stops? a Quantitative Investigation of the Globalization Hazard-Moral Hazard Tradeoff

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  • Enrique G. Mendoza
  • Ceyhun Bora Durdu

Abstract

An implication of the "globalization hazard" hypothesis is that sudden stops could be prevented by offering foreign investors price guarantees on emerging markets assets. These guarantees create a tradeoff, however, because they weaken globalization hazard by creating international moral hazard. We study this tradeoff using an equilibrium asset-pricing model. Without guarantees, margin calls and trading costs cause Sudden Stops driven by Fisher''s debt-deflation process. Price guarantees prevent this deflation by propping up foreign asset demand, but their effectiveness and welfare implications depend critically on the price elasticity of foreign demand and on making the guarantees contingent on debt levels.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/73.

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Length: 40
Date of creation: 01 Mar 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/73

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Keywords: Moral hazard; Economic models; price guarantees; bonds; trading costs; bond; asset market; present value; trade costs; equity market; overvaluation; open economy; world demand; current account deficit; domestic economy; equilibrium model; asset markets; domestic firms; financial markets; domestic demand; world output; bond market; political economy; foreign bonds; net exports; stock of capital; bond purchases; price fluctuations; domestic capital; international capital; state bond; partial equilibrium; domestic savings; discount rate; hedge; stock market; derivative; dynamic gains; international capital markets; foreign bond; income from bonds; net present value; financial intermediaries; stock market capitalization; domestic goods; valuation of asset; interest income from bonds; competitive market; external shocks;

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  1. Enrique G. Mendoza, 1991. "Capital Controls and the Gains from Trade in a Business Cycle Model of a Small Open Economy," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 480-505, September.
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