Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices

Mendoza, Enrique G.; Smith, Katherine A.

doi:10.1016/j.jinteco.2005.06.016

Cited by 154 publications

(195 citation statements)

References 29 publications

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“…Another mechanism, termed the Fisherian debt-deflation channel by Mendoza (2001), emphasizes that a sudden stop, given collateral constraints, might induce margin calls, a sell-off of assets and consequently a contraction of credit and output (e.g., Kiyotaki and Moore, 1997, and Mendoza and Smith, 2006. 4 In these frameworks, even though the government sector is typically not modeled, it is likely that a Keynesian prescription of expanding demand through expansionary fiscal and monetary policies would reduce the severity of a sudden stop crisis.…”

Section: Why Should a Sudden Top Cause A Collapse In Output?mentioning

confidence: 99%

Fiscal and monetary policies and the cost of sudden stops

Hutchison¹,

Noy²,

Wang³

2010

Journal of International Money and Finance

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This article investigates the effects of macroeconomic policy (monetary and fiscal) on output growth during financial crises characterized by a "sudden stop" in net capital inflows in developing and emerging market economies. We investigate 83 sudden stop crises in 77 countries over 1982-2003 using a baseline empirical model to control for the various determinants of output losses during sudden stop crises. Extending the baseline model to account for policies--contractionary as well as expansionary--we measure the marginal effects of policy on output losses. Simple descriptive statistics indicate no apparent correlation between the costs of financial crises and the economic policies pursed at the time. Once controlling for various pre-conditions and other factors, however, we find that monetary and fiscal tightening at the time of a sudden stop crisis significantly worsens output losses. JEL: E52, E62, F32, F43, O16

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Section: Why Should a Sudden Top Cause A Collapse In Output?mentioning

confidence: 99%

Fiscal and monetary policies and the cost of sudden stops

Hutchison¹,

Noy²,

Wang³

2010

Journal of International Money and Finance

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“…The first term on the right hand side of the equation (2.22) shows the direct effect of the binding of the collateral constraint on the excess return on sovereign bond i, as first shown in Aiyagari and Gertler (1999) and extended to an open economy setting by Mendoza and Smith (2006). When the collateral constraint binds, the first term on the right hand becomes positive due to the positive µ t , increasing the excess return on the sovereign bond i, which means a decrease in the bond price Q i t (i.e., an increase in the cost of borrowing for countries in group i) due to the external financing premium.…”

Section: External Financing Premium On Debtmentioning

confidence: 85%

“…Table 1 in Introduction. 20 Moreover, Spain's default probability conditional on Greece's default in the simulation increases from 1% (the Due to the persistence of the income shock process, an initial bad income shock to Greece, which finally leads to her default at date 0, starts at dates around -2 or -3. This initial bad shock makes the collateral constraint midly binding through a decrease in Greek bond prices.…”

Section: Event Studymentioning

confidence: 96%

Contagion of Sovereign Default Risk: The Role of Two Financial Frictions.

Park

2014

SSRN Journal

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This paper develops a quantitative general equilibrium model of sovereign default with heterogeneous agents to account for spillover of default risk across countries. Borrowers (sovereign governments) and foreign lenders (investors) in the model face financial frictions, which endogenously determine each agent's credit condition. Due to lack of enforcement in sovereign debt, borrowing constraints for the governments are endogenous to incentives to default for the governments. On the other hand, investors who hold a portfolio of sovereign debts face a collateral constraint that limits their leverage of investment in sovereign debts. When the collateral constraint for investors binds due to a decrease in the value of collateral, triggered by a high default risk for one country, credit constrained investors ask for liquidity premiums even to countries in which there is no worsening of domestic fundamentals. This increase in the cost of borrowing, in turn, increases incentives to default for other countries with normal fundamentals, further constraining investors in obtaining credit through a decrease in the value of collateral. The interplay of each agent's credit condition generates a bad spiral through which we observe spread of default risk across countries. In a quantitative analysis, the model is calibrated to Greece and Spain, and predicts (1) that cross-county correlation in sovereign spreads between Greece and Spain increases significantly during a crisis period, and (2) that Spain's default rate, conditional on Greece' default, increases about three times compared to Spain's unconditional default rate. The model's predictions are consistent with the recent European debt crisis.⇤ I am extremely grateful to Charles Engel for his constant guidance and support. I also thank Dean Corbae, Kenneth West,

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“…Appendix B reports the details of the computation. Aiyagari and Gertler (1999), Mendoza and Smith (2006) and Rampini and Viswanathan (2010) for a discussion of the asset pricing and risk management implications of models with collateral constraints. s 1 are the consumption and the nominal exchange rate in logs at date 1, andw 1 is the nonfinancial present value of households' income at date 1, also in logs.…”

Section: Dollarized Equilibriamentioning

confidence: 99%