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Creditor Moral Hazard in Equity Markets: A Theoretical Framework and Evidence from Indonesia and Korea

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  • Ali M. Kutan

    ()

  • Ayse Y. Evrensel

    ()

Abstract

This paper expands on the work of Sarno and Taylor (1999) and develops three alternative models in which creditor moral hazard might occur in equity markets under different assumptions regarding the existence of asset market bubbles and implicit guarantees. Incorporating IMF-related news associated with the own country and with other countries to our models, we are able to predict the expected change in investor behavior and its effect on stock returns. Using daily stock returns for Indonesia and Korea, we test the ability of the models to predict the expected changes in stock returns on the days of IMF-related news such as program negotiations and program approval. Our results regarding Korea and, to a lesser extent, Indonesia are consistent with the creditor moral hazard models that assume implicit guarantees and asset price bubbles. Our results show that, if there is creditor moral hazard in equity markets, its duration could be measured only by days, suggesting that creditor moral hazard is a short-term phenomenon.

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Bibliographic Info

Paper provided by William Davidson Institute at the University of Michigan in its series William Davidson Institute Working Papers Series with number 2004-659.

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Length: 24 pages
Date of creation: 01 Feb 2004
Date of revision:
Handle: RePEc:wdi:papers:2004-659

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Keywords: Creditor moral hazard; financial markets; the IMF; and news;

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References

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  1. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  2. Topol, Richard, 1991. "Bubbles and Volatility of Stock Prices: Effect of Mimetic Contagion," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 101(407), pages 786-800, July.
  3. John Krainer, 2002. "Stock market volatility," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue oct25.
  4. Evrensel, Ayse Y., 2002. "Effectiveness of IMF-supported stabilization programs in developing countries," Journal of International Money and Finance, Elsevier, Elsevier, vol. 21(5), pages 565-587, October.
  5. Hayo, Bernd & Kutan, Ali M., 2005. "IMF-related news and emerging financial markets," Journal of International Money and Finance, Elsevier, Elsevier, vol. 24(7), pages 1126-1142, November.
  6. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, Elsevier, vol. 19(1), pages 3-29, September.
  7. Sarno, Lucio & Taylor, Mark P., 1999. "Moral hazard, asset price bubbles, capital flows, and the East Asian crisis:: the first tests," Journal of International Money and Finance, Elsevier, Elsevier, vol. 18(4), pages 637-657, August.
  8. Przeworski, Adam & Vreeland, James Raymond, 2000. "The effect of IMF programs on economic growth," Journal of Development Economics, Elsevier, Elsevier, vol. 62(2), pages 385-421, August.
  9. Steven Phillips & Timothy D. Lane, 2000. "Does IMF Financing Result in Moral Hazard?," IMF Working Papers 00/168, International Monetary Fund.
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Cited by:
  1. Axel Dreher, 2004. "Does the IMF cause moral hazard? A critical review of the evidence," International Finance, EconWPA 0402003, EconWPA, revised 29 Mar 2004.
  2. Jian Tong & Chenggang Xu, 2004. "Financial Sector Returns and Creditor Moral Hazard: Evidence from Indonesia, Korea, and Thailand," William Davidson Institute Working Papers Series, William Davidson Institute at the University of Michigan 2004-687, William Davidson Institute at the University of Michigan.

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