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

42 Pages Posted: 26 Apr 2006

See all articles by Ceyhun Bora Durdu

Ceyhun Bora Durdu

Board of Governors of the Federal Reserve System

Enrique G. Mendoza

National Bureau of Economic Research (NBER); University of Pennsylvania

Multiple version iconThere are 2 versions of this paper

Date Written: March 2006

Abstract

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.

Keywords: Sudden Stops, Fisherian deflation, globalization hazard, moral hazard, price guarantees

JEL Classification: F41, F32, E44, D52

Suggested Citation

Durdu, Ceyhun Bora and Mendoza, Enrique G., Are Asset Price Guarantees Useful for Preventing Sudden Stops? A Quantitative Investigation of the Globalization Hazard-Moral Hazard Tradeoff (March 2006). IMF Working Paper No. 06/73, Available at SSRN: https://ssrn.com/abstract=898734

Ceyhun Bora Durdu (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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HOME PAGE: http://www.ceyhunbora.com

Enrique G. Mendoza

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

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