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Hot Money

  • V. V. Chari
  • Patrick J. Kehoe

Recent empirical work on financial crises documents that crises tend to occur when macroeconomic fundamentals are weak; but even after conditioning on an exhaustive list of fundamentals, a sizable random component to crises and associated capital flows remains. We develop a model of herd behavior consistent with these observations. Informational frictions together with standard debt default problems lead to volatile capital flows resembling hot money and financial crises. We show that repaying debt during difficult times identifies a government as financially resilient, enhances its reputation, and stabilizes capital flows. Bailing out governments deprives resilient countries of the opportunity to differentiate themselves from the nonresilient.

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Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 111 (2003)
Issue (Month): 6 (December)
Pages: 1262-1292

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Handle: RePEc:ucp:jpolec:v:111:y:2003:i:6:p:1262-1292
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  1. V. V. Chari & Patrick J. Kehoe, 2002. "On the robustness of herds," Working Papers 622, Federal Reserve Bank of Minneapolis.
  2. Jeffrey Sachs & Aaron Tornell & Andres Velasco, 1996. "The Mexican Peso Crisis: Sudden Death or Death Foretold?," NBER Working Papers 5563, National Bureau of Economic Research, Inc.
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  16. repec:oup:qjecon:v:107:y:1992:i:3:p:797-817 is not listed on IDEAS
  17. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
  18. Graciela Laura Kaminsky, 1999. "Currency and Banking Crises: The Early Warnings of Distress," IMF Working Papers 99/178, International Monetary Fund.
  19. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October.
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