Financial Integration Without the Volatility

61 Pages Posted: 4 Dec 2006

See all articles by Ricardo J. Caballero

Ricardo J. Caballero

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Kevin Cowan

Central Bank of Chile

Date Written: May 15, 2008

Abstract

Integration to international capital markets is one of the key pillars of development. However, capital flows also bring volatility to emerging markets. Are there mechanisms to reap the benefits of capital flows without being hurt by their volatility? Are current practices, such as large reserves accumulation, public deleveraging, and export promotion strategies, efficient external insurance mechanisms? In this paper we start by documenting the external volatility faced by emerging markets as well as current self-insurance practices, especially among prudent economies. We then provide a simple model that illustrates the inefficient nature of these practices. We argue that with the help of the IFIs in developing the right contingent markets, similar protection could be obtained at lower cost by using financial hedging strategies. We also argue that, at least for now, local governments have an important role to play in the implementation of these external insurance mechanisms.

JEL Classification: E2, E3, F3, F4, G0, C1

Suggested Citation

Caballero, Ricardo J. and Cowan, Kevin, Financial Integration Without the Volatility (May 15, 2008). MIT Department of Economics Working Paper No. 08-04, Available at SSRN: https://ssrn.com/abstract=948579 or http://dx.doi.org/10.2139/ssrn.948579

Ricardo J. Caballero (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Kevin Cowan

Central Bank of Chile ( email )

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Santiago
Chile

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