Coping with Risk Through Mismatches: Domestic and International Financial Contracts for Emerging Economies

41 Pages Posted: 15 Jan 2004

See all articles by Augusto de la Torre

Augusto de la Torre

Columbia University, School of International & Public Affairs (SIPA), Students

Sergio L. Schmukler

World Bank - Development Research Group (DECRG)

Date Written: February 2, 2004

Abstract

This paper argues that short termism, dollarization, and the use of foreign jurisdictions are endogenous ways of coping with systemic risks prevalent in emerging markets. They represent a symptom at least as much as a problem. These coping mechanisms are jointly determined and the choice of one of them involves risk tradeoffs. Various conclusions can be derived from the analysis. First, because of the dominance of dollar contracts over short-duration contracts, dedollarization might be much more difficult to achieve than often believed. Second, one-dimensional policies aimed at reducing currency and duration mismatches might just displace risk and not diminish it. Third, as systemic risks rise, the market equilibrium settles in favor of investor protection against price risk (through dollar and short-duration contracts) at the expense of exposure to credit risk. Finally, the option value to litigate in the event of default might explain this equilibrium outcome.

Keywords: Currency mismatch, maturity mismatch, dollarization, financial development

JEL Classification: F33, F34, F36, G15, G18

Suggested Citation

de la Torre, Augusto and Schmukler, Sergio, Coping with Risk Through Mismatches: Domestic and International Financial Contracts for Emerging Economies (February 2, 2004). World Bank Working Paper No. 3212. Available at SSRN: https://ssrn.com/abstract=486142 or http://dx.doi.org/10.2139/ssrn.486142

Augusto De la Torre

Columbia University, School of International & Public Affairs (SIPA), Students ( email )

420 West 118th Street
New York, NY
United States

Sergio Schmukler (Contact Author)

World Bank - Development Research Group (DECRG) ( email )

1818 H. Street, N.W.
MSN MC 3-301
Washington, DC 20433
United States
202-458-4167 (Phone)
202-522-3518 (Fax)

HOME PAGE: http://www.worldbank.org/en/about/people/s/sergio-schmukler

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