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Contagion of Financial Crises in Sovereing Debt Markets

  • 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
Date of revision:
Handle: RePEc:cie:wpaper:0906
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  1. Igor Livshits & James MacGee & Michele Tertilt, 2003. "Consumer bankruptcy: a fresh start," Working Papers 617, Federal Reserve Bank of Minneapolis.
  2. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
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  4. Reinhart, Carmen & Kaminsky, Graciela, 2008. "The center and the periphery: The globalization of financial turmoil," MPRA Paper 14100, University Library of Munich, Germany.
  5. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Staff Report 410, Federal Reserve Bank of Minneapolis.
  6. Garry J. Schinasi & R. Todd Smith, 2000. "Portfolio Diversification, Leverage, and Financial Contagion," IMF Staff Papers, Palgrave Macmillan, vol. 47(2), pages 1.
  7. Sandra Lizarazo & Jose Maria Da-Rocha, 2009. "Money, Credit and Default," Working Papers 0908, Centro de Investigacion Economica, ITAM.
  8. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & Jose-Victor Rios-Rull, 2002. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Centro de Alti­simos Estudios Ri­os Pe©rez(CAERP) 2, Centro de Altisimos Estudios Rios Perez (CAERP).
  9. Taimur Baig & Ilan Goldfajn, 1999. "Financial Market Contagion in the Asian Crisis," IMF Staff Papers, Palgrave Macmillan, vol. 46(2), pages 3.
  10. 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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  13. Brian D. Wright & Kenneth M. Kletzer, 2000. "Sovereign Debt as Intertemporal Barter," American Economic Review, American Economic Association, vol. 90(3), pages 621-639, June.
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  15. Kaminsky, Graciela L & Reinhart, Carmen M, 1998. "Financial Crises in Asia and Latin America: Then and Now," American Economic Review, American Economic Association, vol. 88(2), pages 444-48, May.
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  17. Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper 08-02, Federal Reserve Bank of Richmond.
  18. Igor Livshits & James MacGee & Michèle Tertilt, 2010. "Accounting for the Rise in Consumer Bankruptcies," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 165-93, April.
  19. International Monetary Fund, 1999. "Sources of Contagion; Finance or Trade?," IMF Working Papers 99/146, International Monetary Fund.
  20. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2008. "Heterogeneous borrowers in quantitative models of sovereign default," Working Paper 07-01, Federal Reserve Bank of Richmond.
  21. Kristin Forbes, 2000. "The Asian Flu and Russian Virus: Firm-level Evidence on How Crises are Transmitted Internationally," NBER Working Papers 7807, National Bureau of Economic Research, Inc.
  22. Bewley, Truman, 1983. "A Difficulty with the Optimum Quantity of Money," Econometrica, Econometric Society, vol. 51(5), pages 1485-504, September.
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  25. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
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