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Are Asset Price Guarantees Useful for Preventing Sudden Stops?A Quantitative Investigation of the Globalization Hazard-Moral Hazard Tradeoff

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  • Mr. Enrique G. Mendoza
  • Ceyhun Bora Durdu

Abstract

An implication of the "globalization hazard" hypothesis is that sudden stops could be prevented by offering foreign investors price guarantees on emerging markets assets. These guarantees create a tradeoff, however, because they weaken globalization hazard by creating international moral hazard. We study this tradeoff using an equilibrium asset-pricing model. Without guarantees, margin calls and trading costs cause Sudden Stops driven by Fisher's debt-deflation process. Price guarantees prevent this deflation by propping up foreign asset demand, but their effectiveness and welfare implications depend critically on the price elasticity of foreign demand and on making the guarantees contingent on debt levels.

Suggested Citation

  • Mr. Enrique G. Mendoza & Ceyhun Bora Durdu, 2006. "Are Asset Price Guarantees Useful for Preventing Sudden Stops?A Quantitative Investigation of the Globalization Hazard-Moral Hazard Tradeoff," IMF Working Papers 2006/073, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:2006/073
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    Cited by:

    1. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
    2. Hélène Rey & Philippe Martin, 2006. "Globalization and Emerging Markets: With or Without Crash?," American Economic Review, American Economic Association, vol. 96(5), pages 1631-1651, December.
    3. C. Bora Durdu, 2011. "Review of "Emerging Markets Resilience and Growth Amid Global Turmoil by M. Ayhan Kose and Eswar S. Prasad"," Koç University-TUSIAD Economic Research Forum Working Papers 1111, Koc University-TUSIAD Economic Research Forum.
    4. Daniel Levy & Tamir Mayer & Alon Raviv, 2020. "Academic Scholarship in Light of the 2008 Financial Crisis: Textual Analysis of NBER Working Papers," Working Papers 2020-01, Bar-Ilan University, Department of Economics.
    5. Benguria, Felipe & Matsumoto, Hidehiko & Saffie, Felipe, 2022. "Productivity and trade dynamics in sudden stops," Journal of International Economics, Elsevier, vol. 139(C).
    6. repec:hal:spmain:info:hdl:2441/9261 is not listed on IDEAS
    7. Javier Bianchi, 2016. "Efficient Bailouts?," American Economic Review, American Economic Association, vol. 106(12), pages 3607-3659, December.
    8. Guillermo A. Calvo, 2008. "Crises in Emerging Markets Economies: A Global Perspective," Central Banking, Analysis, and Economic Policies Book Series, in: Kevin Cowan & Sebastián Edwards & Rodrigo O. Valdés & Norman Loayza (Series Editor) & Klaus Schmidt- (ed.),Current Account and External Financing, edition 1, volume 12, chapter 3, pages 085-115, Central Bank of Chile.
    9. Levy, Daniel & Mayer, Tamir & Raviv, Alon, 2022. "Economists in the 2008 financial crisis: Slow to see, fast to act," Journal of Financial Stability, Elsevier, vol. 60(C).
    10. Emine Boz & C. Bora Durdu & Nan Li, 2015. "Emerging Market Business Cycles: The Role of Labor Market Frictions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(1), pages 31-72, February.
    11. Hutchison, Michael M. & Noy, Ilan & Wang, Lidan, 2010. "Fiscal and monetary policies and the cost of sudden stops," Journal of International Money and Finance, Elsevier, vol. 29(6), pages 973-987, October.
    12. Enrique G. Mendoza, 2006. "Lessons from the Debt-Deflation Theory of Sudden Stops," American Economic Review, American Economic Association, vol. 96(2), pages 411-416, May.
    13. Urban J. Jermann, 2017. "Financial Markets' Views about the Euro–Swiss Franc Floor," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(2-3), pages 553-565, March.
    14. Durdu, Ceyhun Bora & Mendoza, Enrique G. & Terrones, Marco E., 2009. "Precautionary demand for foreign assets in Sudden Stop economies: An assessment of the New Mercantilism," Journal of Development Economics, Elsevier, vol. 89(2), pages 194-209, July.
    15. Durdu, Ceyhun Bora, 2009. "Quantitative implications of indexed bonds in small open economies," Journal of Economic Dynamics and Control, Elsevier, vol. 33(4), pages 883-902, April.
    16. Emine Boz & C. Bora Durdu & Nan Li, 2015. "Emerging Market Business Cycles: The Role of Labor Market Frictions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(1), pages 31-72, February.
    17. Enrique G. Mendoza & Katherine A. Smith, 2014. "Financial Globalization, Financial Crises, and the External Portfolio Structure of Emerging Markets," Scandinavian Journal of Economics, Wiley Blackwell, vol. 116(1), pages 20-57, January.
    18. C. Bora Durdu, 2006. "Quantitative Implications of Indexed Bonds in Small Open Economies: Working Paper 2006-12," Working Papers 18245, Congressional Budget Office.
    19. Koehler-Geib, Friederike Norma, 2008. "The Effect of Uncertainty on the Occurrence and Spread of Financial Crises," Munich Dissertations in Economics 8067, University of Munich, Department of Economics.
    20. Enrique G. Mendoza & Katherine A. Smith, 2013. "Financial Globalization, Financial Crises, and the External Portfolio Structure of Emerging Markets," NBER Working Papers 19072, National Bureau of Economic Research, Inc.
    21. Katherine A. Smith & Enrique G. Mendoza, 2011. "Financial Globalization, Financial Crisis, and the External Capital Structure of Emerging Markets," 2011 Meeting Papers 235, Society for Economic Dynamics.
    22. Javier Bianchi & Enrique Mendoza, 2020. "A Fisherian Approach to Financial Crises: Lessons from the Sudden Stops Literature," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 254-283, August.
    23. Ceyhun Bora Durdu & Serdar Sayan, 2010. "Emerging Market Business Cycles with Remittance Fluctuations," IMF Staff Papers, Palgrave Macmillan, vol. 57(2), pages 303-325, June.
    24. Anton Korinek & Enrique G. Mendoza, 2013. "From Sudden Stops to Fisherian Deflation: Quantitative Theory and Policy Implications," NBER Working Papers 19362, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    WP; price guarantee; real interest rate; equity price; present value;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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