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

By Enrique G. Mendoza, Ceyhun Bora Durdu

March 1, 2006

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Enrique G. Mendoza, and Ceyhun Bora Durdu. Are Asset Price Guarantees Useful for Preventing Sudden Stops?A Quantitative Investigation of the Globalization Hazard-Moral Hazard Tradeoff, (USA: International Monetary Fund, 2006) accessed November 12, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Asset prices, Consumption, Moral hazard, Stocks, Sudden stops

Keywords: Equity price, Present value, Price guarantee, Real interest rate, WP

Publication Details

Pages:

40
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2006/073
Stock No:

WPIEA2006073
ISBN:

9781451863338
ISSN:

1018-5941

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