63,310 research outputs found
Financial Integration and International Risk Sharing
Conventional wisdom suggests that financial liberalization can help countries insure against idiosyncratic
risk. There is little evidence, however, that countries have increased risk sharing despite recent
widespread financial liberalization. This work shows that the key to understanding this puzzling observation
is that conventional wisdom assumes frictionless international financial markets, while actual
international financial markets are far from frictionless. In particular, financial contracts are incomplete
and enforceability of debt repayment is limited. Default risk of debt contracts constrains borrowing, and
more importantly, it makes borrowing more difficult in bad times, precisely when countries need insurance
the most. Thus, default risk of debt contracts hinders international risk sharing. When countries
remove their official capital controls, default risk is still present as an implicit barrier to capital flows;
the observed increase in capital flows under financial liberalization is in fact too limited to improve risk
sharing. If default risk of debt contracts were eliminated, capital flows would be six times greater, and
international risk sharing would increase substantially.international risk sharing, financial integration, financial liberalization, financial frictions, sovereign default, international capital flows
Duration of Sovereign Debt Renegotiation
The structure of sovereign debt has evolved over time from illiquid bank loans toward liquid bonds
that are traded on the secondary market in the past two decades. This change in the debt structure
is accompanied with a reduction in the duration of sovereign debt renegotiation; it takes on average 9
years to restructure bank loans, but only 1 year to restructure bonds. In this work, we argue that the
secondary market plays an important role -- information revelation -- in reducing the renegotiation
length. We construct a dynamic bargaining game between the government and the creditors with private
information on the creditors' reservation value. The government uses costly delays as a screening device
for the creditors' type, and so the delays arise in equilibrium. Moreover, the more severe is the private
information, the longer the delays are. When we introduce the secondary market, the equilibrium delays
are greatly reduced. This is because the secondary market price conveys information about the creditors'
reservation and lessens the information friction. We also find that bond financing is more friendly to the
debtor country; it increases ex-ante borrowing and investment and ex-post renegotiation welfare of the government.sovereign debt renegotiation, secondary bond markets, dynamic bargaining, incomplete information
Financial Integration and International Risk Sharing
In the last two decades, financial integration has increased dramatically across the world. At the same time, the fraction of countries in default has more than doubled. Contrary to theory,
however, there appears to have been no substantial improvement in the degree of international risk sharing. To account for this puzzle, we construct a general equilibrium model that features a continuum of countries and default choices on state-uncontingent bonds. We model increased
financial integration as a decrease in the cost of borrowing.
Our main finding is that as the cost of borrowing is lowered, financial integration and sovereign default increases substantially, but the degree of risk sharing as measured by cross section and panel regressions increases hardly at all. The explanation, we propose, is that international risk sharing is not sensitive to the increase in financial integration given the current magnitude of capital flows because countries can insure themselves through accumulation of domestic assets.
To get better risk sharing, capital flows among countries need to be extremely large. In addition, although the ability to default on loans provides state contingency, it restricts international risk
sharing in two ways: higher borrowing rates and future exclusion from international credit marketsFinanical Integration, Risk Sharing, Globalization, Sovereign Debt
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