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Contagion and Volatility with Imperfect Credit Markets


  • Pierre-Richard Agenor
  • Joshua Aizenman


This paper interprets contagion effects as a perceived increase (triggered by events occurring elsewhere) in the volatility of aggregate shocks impinging on the domestic economy. The implications of this approach are analyzed in a model with two types of credit market imperfections: domestic banks borrow at a premium on world capital markets, and domestic producers (whose demand for credit results from working capital needs) borrow at a premium from domestic banks which possess comparative advantage in monitoring the behavior of domestic agents. Financial intermediation spreads are shown to be determined by a markup that compensates for the expected cost of contract enforcement and state verification and for the expected revenue lost in adverse states of nature. Higher volatility of producers' productivity shocks increases both financial spreads and the producers' cost of capital, resulting in lower employment and higher incidence of default. The welfare effects of volatility are non-linear. Higher volatility does not impose any welfare cost for countries characterized by relatively low volatility and efficient financial intermediation. The adverse welfare effects are large (small) for countries that are at the threshold of full integration with international capital markets (close to financial autarky), that is, countries characterized by a relatively low (high) probability of default.

Suggested Citation

  • Pierre-Richard Agenor & Joshua Aizenman, 1997. "Contagion and Volatility with Imperfect Credit Markets," NBER Working Papers 6080, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6080
    Note: IFM

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    References listed on IDEAS

    1. Joshua Aizenman & Michael Gavin & Ricardo Hausmann, 2001. "Optimal tax and debt policy with endogenously imperfect creditworthiness," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 9(4), pages 367-395.
    2. Calvo, Guillermo A. & Kaminsky, Graciela L., 1991. "Debt relief and debt rescheduling : The optimal-contract approach," Journal of Development Economics, Elsevier, vol. 36(1), pages 5-36, July.
    3. Martin Uribe, 1996. "The Tequila effect: theory and evidence from Argentina," International Finance Discussion Papers 552, Board of Governors of the Federal Reserve System (U.S.).
    4. Ilan Goldfajn & Rodrigo Valdés, 1997. "Balance of Payments Crises and Capital Flows: The Role of Liquidity," Working Papers Central Bank of Chile 11, Central Bank of Chile.
    5. Luis Catão, 1997. "Bank Credit in Argentina in the Aftermath of the Mexican Crisis; Supply or Demand Constrained?," IMF Working Papers 97/32, International Monetary Fund.
    6. Jaffee, Dwight & Stiglitz, Joseph, 1990. "Credit rationing," Handbook of Monetary Economics,in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 16, pages 837-888 Elsevier.
    7. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
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    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration


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