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

Author/Editor:

Enrique G. Mendoza ; Ceyhun Bora Durdu

Publication Date:

March 1, 2006

Electronic Access:

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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.

Series:

Working Paper No. 2006/073

Subject:

English

Publication Date:

March 1, 2006

ISBN/ISSN:

9781451863338/1018-5941

Stock No:

WPIEA2006073

Pages:

40

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