TY - JOUR
AU - Caballero,Ricardo J.
AU - Panageas,Stavros
TI - Hedging Sudden Stops and Precautionary Contractions
JF - National Bureau of Economic Research Working Paper Series
VL - No. 9778
PY - 2003
Y2 - June 2003
UR - http://www.nber.org/papers/w9778
L1 - http://www.nber.org/papers/w9778.pdf
N1 - Author contact info:
Ricardo J. Caballero
MIT
Department of Economics
Room E52-373a
Cambridge, MA 02142-1347
Tel: 617/253-0489
Fax: 617/253-6915
E-Mail: caball@mit.edu
Stavros Panageas
University of Chicago
Booth School of Business
5807 South Woodlawn Avenue
Chicago, IL, 60637
Tel: (773) 834 4711
E-Mail: stavros.panageas@chicagobooth.edu
AB - Even well managed emerging market economies are exposed to significant external risk, the bulk of which is financial. At a moment's notice, these economies may be required to reverse the capital inflows that have supported the preceding boom. While capital flows crises are sudden nonlinear events (sudden stops), their likelihood fluctuates over time. The question we address in the paper is how should a country react to these fluctuations. Depending on the hedging possibilities the country faces, the options range from pure self-insurance to hedging the sudden stop jump itself. In between, there is the more likely possibility to hedge the smoother fluctuations in the likelihood of sudden stops. The main contribution of the paper is to provide an analytically and empirically tractable model that allows us to characterize and quantify optimal contingent liability management in a variety of scenarios. We show, with a concrete example, that the gains from contingent liability management can easily exceed the equivalent of cutting a country's external liabilities by 10 percent of GDP.
*This is a revision of the June 2003 version.
ER -