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Volatile capital flows and financial integration: The role of moral hazard

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  • Kikuchi, Tomoo
  • Stachurski, John
  • Vachadze, George

Abstract

We study a model in which income and capital flows between countries are jointly determined in a world economy with integrated financial markets. In a setting that combines risky entrepreneurial activity with moral hazard, we find that a shift from autarky to financial integration leads to boom-bust cycles in capital flows, output and consumption. Moral hazard causes cycles because financial intermediaries incentivize effort by insisting entrepreneurs take an equity share in their own projects. The size of this stake rises with wealth, discouraging entrepreneurship and inhibiting capital formation. The reverse is true when wealth falls, generating cycles.

Suggested Citation

  • Kikuchi, Tomoo & Stachurski, John & Vachadze, George, 2018. "Volatile capital flows and financial integration: The role of moral hazard," Journal of Economic Theory, Elsevier, vol. 176(C), pages 170-192.
  • Handle: RePEc:eee:jetheo:v:176:y:2018:i:c:p:170-192
    DOI: 10.1016/j.jet.2018.03.009
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    Cited by:

    1. Wai-Hong Ho, 2017. "Financial market globalization, nonconvergence and credit cycles," Annals of Finance, Springer, vol. 13(2), pages 153-180, May.

    More about this item

    Keywords

    Capital flows; Moral hazard; Cycles; Financial integration;

    JEL classification:

    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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