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Capital Mobility In A Second--Best World: Moral Hazard With Costly Financial Intermediation

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  • Joshua Aizenman

    (University of California, Santa Cruz, USA)

Abstract

The paper studies financial integration in the presence of moral hazard, where banks may mitigate excessive risk by costly monitoring. The author shows that a drop in banks" cost of funds, less efficient intermediation technology, higher macroeconomic volatility, and a more generous deposit insurance raise the riskiness of projects in a competitive equilibrium. Overborrowing would arise even in the absence of deposit insurance in circumstances where the cost of risk monitoring is high, the banks" cost of funds is relatively low, and macroeconomic volatility is high. Reforming an inefficient banking system and improving its operation is a precondition for successful financial integration. Copyright Blackwell Publishing Ltd. 2003

Suggested Citation

  • Joshua Aizenman, 2003. "Capital Mobility In A Second--Best World: Moral Hazard With Costly Financial Intermediation," Review of International Economics, Wiley Blackwell, vol. 11(1), pages 1-17, February.
  • Handle: RePEc:bla:reviec:v:11:y:2003:i:1:p:1-17
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    References listed on IDEAS

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    1. Dooley, Michael P, 2000. "A Model of Crises in Emerging Markets," Economic Journal, Royal Economic Society, vol. 110(460), pages 256-272, January.
    2. Pierre-Richard Agénor & Joshua Aizenman, 1998. "Contagion and Volatility with Imperfect Credit Markets," IMF Staff Papers, Palgrave Macmillan, vol. 45(2), pages 207-235, June.
    3. Takatoshi Ito & Anne O. Krueger, 1996. "Financial Deregulation and Integration in East Asia, NBER-EASE Volume 5," NBER Books, National Bureau of Economic Research, Inc, number ito_96-1, April.
    4. Jaffee, Dwight & Stiglitz, Joseph, 1990. "Credit rationing," Handbook of Monetary Economics,in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 16, pages 837-888 Elsevier.
    5. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    6. Edwards, Sebastian & Vegh, Carlos A., 1997. "Banks and macroeconomic disturbances under predetermined exchange rates," Journal of Monetary Economics, Elsevier, vol. 40(2), pages 239-278, October.
    7. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    8. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    9. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
    10. Edwards, Sebastian & van Wijnbergen, Sweder, 1986. "The Welfare Effects of Trade and Capital Market Liberalization," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 27(1), pages 141-148, February.
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    Cited by:

    1. Agenor, Pierre-Richard & Aizenman, Joshua, 1998. "Volatility and the welfare costs of financial market integration," Policy Research Working Paper Series 1974, The World Bank.
    2. Buch, Claudia M., 1999. "Chilean-type capital controls: A building block of the new international financial architecture?," Kiel Discussion Papers 350, Kiel Institute for the World Economy (IfW).
    3. Claudia M. Buch & Stefan M. Golder, 2000. "Foreign competition and disintermediation: no threat to the German banking system?," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 53(213), pages 107-133.
    4. Buiter, Willem H. & Sibert, Anne, 1999. "UDROP: A Small Contribution to the New International Financial Architecture," CEPR Discussion Papers 2138, C.E.P.R. Discussion Papers.
    5. Dominic Wilson, 2001. "Managing Capital Flows: A Distortions Approach," Asia Pacific Economic Papers 312, Australia-Japan Research Centre, Crawford School of Public Policy, The Australian National University.
    6. Cécile Bastidon, 2002. "Financement extérieur des Pays en Développement : une revue de la littérature des modèles de dette et de crises financières," Post-Print hal-00730937, HAL.
    7. Claudia M. Buch, 2000. "Capital Market Integration in Euroland: The Role of Banks," German Economic Review, Verein für Socialpolitik, vol. 1(4), pages 443-464, November.
    8. Buch, Claudia M. & Golder, Stefan M., 2001. "Foreign versus domestic banks in Germany and the US: a tale of two markets?," Journal of Multinational Financial Management, Elsevier, vol. 11(4-5), pages 341-361, December.

    More about this item

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F2 - International Economics - - International Factor Movements and International Business

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