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Are asset price guarantees useful for preventing Sudden Stops?: A quantitative investigation of the globalization hazard-moral hazard tradeoff

  • Durdu, Ceyhun Bora
  • Mendoza, Enrique G.

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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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 69 (2006)
Issue (Month): 1 (June)
Pages: 84-119

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Handle: RePEc:eee:inecon:v:69:y:2006:i:1:p:84-119
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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  2. Aiyagari, S.R. & Gertler, M., 1998. ""Overreaction" of Asset Prices in General Equilibrium," Working Papers 98-25, C.V. Starr Center for Applied Economics, New York University.
  3. Enrique G. Mendoza, 2005. "Sudden Stops in an Equilibrium Business Cycle Model with Credit Constraints: A Fisherian Deflation of Tobin's Q," 2005 Meeting Papers 307, Society for Economic Dynamics.
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