Capital Flight and Sovereign Default
Abstract:
We explore the deleverage effects through which a sovereign default can disrupt the domestic economy through its banking system. First, a default not only creates a negative balance-sheet effect on domestic banks, but also causes these banks to delever via foreign investment withdrawal. Such deleverage undermines the overall return of domestic private sectors by suppressing the endogenous growth opportunities. Due to the diminished investment returns, banks have to divert resources from domestic Hi-Tech industries to foreign markets. The capital flight occurs with sharp contraction in employment and aggregate output. A quantitative analysis of the model shows that this mechanism generates a deep and persistent fall in post-default output, which accounts for the government’s commitment necessary to explain observed levels of capital flows, private sector credits and Hi-Tech exports. The model is used to study policies that address the government’s lack of commitment.
Presented or Accepted for Presentation at:
- Advanced Computational Economics and Finance, May 2019, Zürich
Arbitrage with Production, Collateral Constraints and Heterogeneous Beliefs
Abstract:
We construct a dynamic model economy in which households from segmented markets have varying financial asset demands. Intermediaries make profit by exploiting the price difference in segmented financial markets. Meanwhile, they are required to separately post their physical investment as collateral to support liquidity supply. We show that with homogeneous belief the intermediaries exhibit self-recovery capacity after negative shocks. We also demonstrate that the heterogeneous belief can disturb such self-recovery process through the tightening of collateral constraints based on belief disagreement. The dynamic interaction between belief determined collateral constraint and liquidity supply turns out to be a powerful transmission mechanism by which the effects of shocks persist, amplify and spill over to other sectors.
Presented or Accepted for Presentation at:
- SFI Finance Workshop, October 2016, Zürich
- EEA-ESEM 2016, August 2016, Geneva