Excessive Dollar Debt: Financial Development and Underinsurance

By Ricardo J. Caballero, Arvind Krishnamurthy. 2003

363 citations recorded by the source corpus.

We propose that the limited financial development of emerging markets is a significant factor behind the large share of dollar-denominated external debt present in these markets. We show that when financial constraints affect borrowing and lending between domestic agents, agents undervalue insuring against an exchange rate depreciation. Since more of this insurance is present when external debt is denominated in domestic currency rather than in dollars, this result implies that domestic agents choose excessive dollar debt. We also show that limited financial development reduces the incentives for foreign lenders to enter emerging markets. The retarded entry reinforces the underinsurance problem.

Subfields: Accounting, Finance

View Paper: https://www.semanticscholar.org/paper/40d53a0b5e39a3b90ddcc8b84b2fb9786f3e0e9d

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Citations in the corpus

Amplification Mechanisms in Liquidity Crises (2009, background): “See Caballero and Krishnamurthy (2003, 2004) or Lorenzoni (2008) for a full treatment of ex-ante policies.”
Mundell-Fleming Lecture: Contractionary Currency Crashes in Developing Countries (2005, background): “27The analytical literature on balance sheet effects and output contraction includes, but is not limited to, Aghion, Bacchetta, and Banerjee (2000); Caballero and Krishnamurthy (2003); Céspedes, Chang, and Velasco (2003 and 2004); Chang and Velasco (1999); Christiano, Gust, and Roldos (2004); Dornbu”
The New Economics of Prudential Capital Controls: A Research Agenda (2011, background): “Caballero and Krishnamurthy (2003) finds that individual market participants do not internalize that less dollar borrowing and more contingent forms of debt would mitigate the pecuniary externalities on interest rates and the exchange rate that emerging market agents experience during times of…”
Macroprudential Regulation versus mopping up after the crash (2020, neutral): “See for example Gromb and Vayanos (2002), Caballero and Krishnamurthy (2003), Lorenzoni (2008), Jeanne and Korinek (2010, 2019), Stein (2012), He and Kondor (2016), D´avila and Korinek (2018) and Korinek (2018) for papers that motivate macroprudential intervention on the basis of pecuniary…”
Dollar Safety and the Global Financial Cycle (2020, methodology): “The new insight of our paper relative to Caballero and Krishnamurthy (2003) is that this the currency mismatch externality is particularly a problem when it comes to dollar borrowing.”
Pecuniary Externalities in Economies with Financial Frictions (2016, background): “Caballero and Krishnamurthy (2003) analyze risk-taking by emerging market agents who 24Prescott and Townsend (1984) show how such pecuniary externalities can be overcome when agents can directly contract consumption levels and no anonymous re-trading is allowed.”
Bubbles and Capital Flow Volatility: Causes and Risk Management (2006, neutral): “In terms of the source of the pecuniary externality and private undervaluation of international liquidity, the mechanism is similar to that in Caballero and Krishnamurthy (2001, 2003).”