Emerging Market Lending: Is Moral Hazard Endogenous?
This paper shows how growth in financially open developing countries is affected when relations with international lenders suffer from the danger of moral hazard. We find that if entrepreneurs can gamble with foreign creditors¡¯ money, borrowing under standard debt contracts is constrained by a No-Gambling Condition similar to that in Hellmann, Murdock, and Stiglitz (2000). However, this incentive constraint is endogenous in the development process: growth increases entrepreneurs¡¯ own capital at risk and thus reduces incentives to gamble. But capital accumulation also decreases the profitability of investment, which has the opposite effect. General equilibrium under moral hazard shows a unique and stable steady state, but involves at least temporary rationing of profitable projects and possibly positive net investment by developing countries in international financial markets.
Volume (Year): 32 (2007)
Issue (Month): 2 (December)
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- Ma, Chien-Hui & Smith, Bruce D., 1996. "Credit market imperfections and economic development: Theory and evidence," Journal of Development Economics, Elsevier, vol. 48(2), pages 351-387, March.
- Galor, Oded & Ryder, Harl E., 1989. "Existence, uniqueness, and stability of equilibrium in an overlapping-generations model with productive capital," Journal of Economic Theory, Elsevier, vol. 49(2), pages 360-375, December.
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