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

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

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The authors argue 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.

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Bibliographic Details
Main Authors: de la Torre, Augusto, Schmukler, Sergio L.
Language:English
en_US
Published: World Bank, Washington, D.C. 2004-02
Subjects:SHORT TERM, DOLLARIZATION, EMERGING MARKETS, RISK, INVESTOR PROTECTION, LITIGATION ACCOUNTING, ADVERSE EFFECTS, ADVERSE SELECTION, AGENCY PROBLEMS, AGENTS, ASSETS, BALANCE SHEETS, BANK DEPOSITS, BANKRUPTCY, CAPITAL FLOWS, CAPITAL MARKETS, CAPITALIZATION, CENTRAL BANKS, CONNECTED LENDING, CONSUMER PRICE INDEX, CONTRACT ENFORCEMENT, CORPORATE GOVERNANCE, CREDIT RISK, CREDIT RISK EXPOSURE, DEBT, DEFAULT RISK, DEPOSITORS, DEPOSITS, DEVALUATION, DISCLOSURE, ECONOMIC GROWTH, ECONOMIC SIZE, ECONOMISTS, EXCHANGE RATES, EXPECTED VALUES, EXPORTS, EXTERNALITIES, FACE VALUE, FINANCIAL CONTRACTS, FINANCIAL CRISES, FINANCIAL INNOVATION, FINANCIAL INTEGRATION, FINANCIAL INTERMEDIATION, FINANCIAL MARKET LIBERALIZATION, FINANCIAL MARKETS, FINANCIAL SECTOR, FINANCIAL SYSTEMS, GDP, GLOBALIZATION, INCENTIVE PROBLEMS, INCOME, INFLATION, INFLATION RATE, INSURANCE, INSURANCE CONTRACTS, INTEREST RATE, LENDING PRACTICES, LIQUIDITY, LITIGATION, M2, MACROECONOMIC POLICY, MACROECONOMIC STABILITY, MARKET EQUILIBRIUM, MONETARY POLICY, MORAL HAZARD, NETWORK EXTERNALITIES, PORTFOLIO, PORTFOLIO DIVERSIFICATION, PRICE RISK, PRIVATE SECTOR, PROBABILITY OF DEFAULT, PUBLIC GOOD, PURCHASING POWER, REAL INTEREST RATE, REAL PRICES, REORGANIZATION, RISK ALLOCATION, RISK AVERSE, RISK REDUCTION, SAFETY NETS, SCALE ECONOMIES, SIDE EFFECTS, STATE INTERVENTION, SUBSIDIARIES, SYSTEMIC RISK, TRANSACTION COSTS, TRANSPARENCY, WEALTH,
Online Access:http://documents.worldbank.org/curated/en/2004/02/3209013/coping-risk-through-mismatches-domestic-international-financial-contracts-emerging-economies
https://hdl.handle.net/10986/14788
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Summary:The authors argue 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.

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