This paper shows how changes in the volatility of the real interest rate at which small open emerging economies borrow have a quantitatively important effect on real variables like output, consumption, investment, and hours worked. To motivate our investigation, we document the strong evidence of time-varying volatility in the real interest rates faced by a sample of four emerging small open

We study the nature of systemic sovereign credit risk using CDS spreads for the U.S. Treasury, individual U.S. states, and major Eurozone countries. Using a multifactor affine framework that allows for both systemic and sovereign-specific credit shocks, we find that there is much less systemic risk among U.S. sovereigns than among Eurozone sovereigns. Thus systemic sovereign risk is not directly caused by macroeconomic integration. We find that both U.S and Eurozone systemic sovereign risk is strongly related to financial market returns. These results provide strong support for the view that systemic sovereign risk has its roots in financial markets rather than in macroeconomic fundamentals.

This study examines how heterogeneity of private information may induce finan-cial contagion. Using a model of multi-asset trading in which the three main channels of contagion through financial linkages in the literature (correlated information, correlated liquidity, and portfolio rebalancing) are ruled out by construction, I show that financial contagion can still be an equilibrium outcome when speculators receive heterogeneous fundamental information. Risk-neutral speculators trade strategically across many assets to mask their information advantage about one asset. Asymmetric sharing of information among them prevents rational market makers from learning about their indivi-dual signals and trades with sufficient accuracy. Incorrect cross-inference about terminal payoffs and contagion ensue. When used to analyze the transmission of shocks across countries, my model suggests that the process of generation and disclosure of information in emerging markets may explain their vulnerability to financial contagion (JEL D82, G14, G15). Many recent financial crises were initiated by episodes of ‘‘local’ ’ turmoil

One plausible mechanism through which financial market shocks may propagate across countries is through the impact that past gains and losses may have on investors ’ risk aversion and behavior. This paper presents a stylized model illustrating how heterogeneous changes in investors ’ risk aversion affect portfolio allocation decisions and stock prices. Our empirical findings suggest that when funds ’ returns are below average, they adjust their holdings toward the average (or benchmark) portfolio. In so doing, funds tend to sell the assets of countries in which they were “overweight”, increasing their exposure to countries in which they were “underweight. ” Based on this insight, the paper constructs an index of “financial interdependence ” which reflects the extent to which countries share overexposed funds. The index helps in explain the pattern of stock market comovement across countries. Moreover, a comparison of this interdependence measure to indices of trade or commercial bank linkages indicates that our index can improve predictions about which

In 2009 all ECB publications feature a motif taken from the €200 banknote. This paper can be downloaded without charge from

In this paper we estimate a heterogeneous expectations model with switching beliefs with two equity markets, Hong Kong and Thailand, during the Asian crisis. We find that investors are heterogeneous in their expectation formation strategies and that they switch between strategies conditional on forecasting ability. During the build-up phase of the crisis, agents active in Thailand are focused on returns in the Hong Kong market, while investors in Hong Kong are focused on fundamentals and past returns. The crisis is induced as Thai investors shift their attention to the fundamental values, and the Hong Kong investors start focusing on Thailand. Therefore, we find evidence of shift-contagion. The model is able to forecast the crisis itself, but not the timing.

Microfinance institutions and other lenders in developing countries rely on the promise of future loans to induce repayment. However, if borrowers expect that others will default, and so loans will no longer be available in the future, then they will default as well. We refer to such contagion as a borrower run. The optimal lending contract must provide additional repayment incentives to counter this tendency to default. We thank seminar audiences at Paris-Jourdan, Toulouse, Williams, Yale, NEUDC, the UC Irvine Development Conference and the Groningen Microfinance Conference for helpful comments. We are especially grateful to Dilip Mookherjee and two anonymous referees for exceptionally thorough readings and constructive suggestions. Any errors are our own.

A number of high-debt emerging-market economies face structural, long-term debt problems that tend to keep their growth rates low, that impart an unequalizing bias to the growth process, that severely constrain social spending and human development, and that make them vulnerable to capital flow reversals. Unless the nature and pace of growth can be improved in these lower-middle income countries, the Millennium Development Goals (MDGs) are unlikely to be met either in many of these countries, or globally. These high-debt emerging-market economies face an impossible choice between draconian and never-ending fiscal austerity, or crisis and a “debt event. ” Both “bitter pills " impose high social and economic costs. This paper proposes the creation of a “Stability and Social Investment Facility ” (SSF) to be housed either at the IMF or the World Bank. It would be a long-term facility to help high-debt emerging market countries cope with and ultimately overcome what will otherwise remain a chronic structural weakness. The SSF would be an instrument providing a steady and predictable source of long-term funds as well as a strong policy signal to help high-debt emerging-market economies reduce their debt burden without having to forgo vital pro-poor social expenditures and growth programs. For the facility to have a significant impact on debt and income dynamics in the eligible countries, we estimate it would need to lend $10-20

This paper provides new systematic evidence of the role of banks ’ reliance on wholesale funding in the international transmission of the financial crisis of 2007-2008. It conducts an event study to estimate the impact of the liquidity crunch of September 15, 2008, on the stock price returns of 772 individual banks across 44 countries, and tests whether differences in abnormal returns relate to these banks ’ ex-ante reliance on wholesale funding. Globally and within countries, banks that relied more heavily in non-deposit sources of funds experienced a significantly larger decline in stock returns even after controlling for other transmission mechanisms.

This paper is prepared for presentation to the Experts ’ Seminar on the “Impact and