Unconditional IMF Financial Support and Investor Moral Hazard

May 1, 2007

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Jun I Kim. Unconditional IMF Financial Support and Investor Moral Hazard, (USA: International Monetary Fund, 2007) accessed November 21, 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

This paper develops a simple model of international lending, and calibrates it to assess quantitatively the effects of contingent IMF financial support on the risk premiums and the crisis probability. In the model, the country borrows in both short and long term; market (coordination) failure triggers a liquidity run and inefficient default; and the IMF lends unconditionally under a preferred creditor status. The model shows that IMF financial support can help prevent a liquidity crisis without causing investor moral hazard by helping to remove a distortion-effectively subsidizing ex post short-term investors (who run for the exit) at the expense of long-term investors (who are locked in). The resulting equilibrium is welfare enhancing as both the country's borrowing costs and the likelihood of a crisis are lower. The calibration exercises suggest that IMF-induced investor moral hazard-which occurs if the IMF lends at a subsidized rate-is unlikely to be a concern in practice, particularly if the country's economic fundamentals are strong and short-term debt is small.

Subject: Bank bailouts, Crisis prevention, Emerging and frontier financial markets, Moral hazard, Return on investment

Keywords: Investor moral hazard, Mover accent, Risk premium, WP

Publication Details

Pages:

36
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2007/104
Stock No:

WPIEA2007104
ISBN:

9781451866681
ISSN:

1018-5941

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