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Contagion of Financial Crises in Sovereing Debt Markets

Listed author(s):
  • Sandra Lizarazo

    ()

    (Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM))

This paper develops a quantitative model of debt, default, and contagion of financial crises for small open economies that interact with risk averse international investors. The paper extends the recent literature on endogenous default risk to the case in which several emerging economies that cannot credibly commit to honor their international debts have common investors. The existence of common investors with preferences that exhibit decreasing absolute risk aversion generates financial links between the emerging economies sovereign debt markets that help to explain the endogenous determination of credit limits, capital flows, and the risk premium in sovereign bond prices as function not only of the economy's fundamentals, the investors' characteristics (wealth, and degree of risk aversion) but more importantly of the fundamentals of other emerging economies. Therefore this paper provides a theoretical formalization that is the base for and endogenous explanation of the contagion of financial crises.

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Paper provided by Centro de Investigacion Economica, ITAM in its series Working Papers with number 0906.

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Length: 65 pages
Date of creation: 2009
Handle: RePEc:cie:wpaper:0906
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  1. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
  2. Sandra Lizarazo & Jose Maria Da-Rocha, 2009. "Money, Credit and Default," Working Papers 0908, Centro de Investigacion Economica, ITAM.
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  9. Bewley, Truman, 1983. "A Difficulty with the Optimum Quantity of Money," Econometrica, Econometric Society, vol. 51(5), pages 1485-1504, September.
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  22. Richard Cantor & Frank Packer, 1996. "Determinants and impact of sovereign credit ratings," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 37-53.
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  24. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2009. "Heterogeneous Borrowers In Quantitative Models Of Sovereign Default," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 50(4), pages 1129-1151, November.
  25. Garry J. Schinasi & R. Todd Smith, 2000. "Portfolio Diversification, Leverage, and Financial Contagion," IMF Staff Papers, Palgrave Macmillan, vol. 47(2), pages 1-1.
  26. International Monetary Fund, 1999. "Sources of Contagion; Finance or Trade?," IMF Working Papers 99/146, International Monetary Fund.
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  28. Xinshen Diao & Wenli Li & Erinc Yeldan, 2000. "How the Asian crisis affected the world economy : a general equilibrium perspective," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 35-59.
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