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Financial Integration Without the Volatility

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  • Ricardo Caballero
  • Kevin Cowan

Abstract

Integration to international capital markets is one of the key pillars of development. However, capital flows also bring volatility to emerging markets. Are there mechanisms to reap the benefits of capital flows without being hurt by their volatility? Are current practices, such as large reserves accumulation, public deleveraging, and export promotion strategies, efficient external insurance mechanisms? In this pa- per we start by documenting the external volatility faced by emerging markets as well as current self-insurance practices, especially among prudent economies. We then provide a simple model that illustrates the inefficient nature of these practices. We argue that with the help of the IFIs in developing the right contingent markets, similar protection could be obtained at lower cost by using financial hedging strategies. We also argue that, at least for now, local governments have an important role to play in the implementation of these external insurance mechanisms.

Suggested Citation

  • Ricardo Caballero & Kevin Cowan, 2006. "Financial Integration Without the Volatility," Working Papers Central Bank of Chile 387, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:387
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    References listed on IDEAS

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    1. Prebisch, Raúl, 1950. "The economic development of Latin America and its principal problems," Sede de la CEPAL en Santiago (Estudios e Investigaciones) 29973, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL).
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    4. Guillermo A. Calvo & Alejandro Izquierdo & Luis-Fernando Mejía, 2004. "On the empirics of Sudden Stops: the relevance of balance-sheet effects," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
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    6. Varangis, Panos & Larson, Don, 1996. "Dealing with commodity price uncertainty," Policy Research Working Paper Series 1667, The World Bank.
    7. Gian Maria Milesi-Ferretti, & Philip R. Lane, 2003. "International Financial Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp03, IIIS.
    8. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December.
    9. Larson, Donald F. & Varangis, Panos & Yabuki, Nanae, 1998. "Commodity risk management and development," Policy Research Working Paper Series 1963, The World Bank.
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    Citations

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    Cited by:

    1. Julian di Giovanni & Andrei A. Levchenko, 2012. "The Risk Content of Exports: A Portfolio View of International Trade," NBER International Seminar on Macroeconomics, University of Chicago Press, vol. 8(1), pages 97-151.
    2. Martin Melecky, 2012. "Choosing The Currency Structure Of Foreign‐Currency Debt: A Review Of Policy Approaches," Journal of International Development, John Wiley & Sons, Ltd., vol. 24(2), pages 133-151, March.
    3. Stuart Landon and Constance Smith, 2015. "Rule-Based Resource Revenue Stabilization Funds: A Welfare Comparison," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    4. Dong, Baomin & Gu, Xinhua & Song, Huasheng, 2017. "Capital market liberalization: Optimal tradeoff and bargaining delay," The North American Journal of Economics and Finance, Elsevier, vol. 39(C), pages 78-88.
    5. Melecky, Martin, 2012. "Macroeconomic dynamics in Macedonia and Slovakia: Structural estimation and comparison," Economic Modelling, Elsevier, vol. 29(4), pages 1377-1387.
    6. Gnangnon, Sèna Kimm, 2013. "Structural vulnerability and excessive public indebtedness in CFA Franc Zone countries," Economic Modelling, Elsevier, vol. 35(C), pages 816-832.
    7. Kevin Cowan L. & José De Gregorio R. & Alejandro Micco A. & Christopher Neilson M., 2007. "Financial Diversification and Sudden Stops," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 10(3), pages 45-65, December.
    8. repec:wbk:wbpubs:28040 is not listed on IDEAS
    9. Melecky, Martin, 2008. "An alternative framework for foreign exchange risk management of sovereign debt," Policy Research Working Paper Series 4458, The World Bank.

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