Essays on Systemic Financial Crises, Default and Pecuniary Externalities

Abstract

The first chapter analyzes how default externalities lead to an excessive incidence of systemic private debt crises. An individual defaulting borrower does not internalize that her default leads to a depreciation in the exchange rate because international lenders will sell any seizable assets and flee the country. The exchange rate depreciation in turn reduces the value of non-tradable collateral and induces other borrowers to default, leading to a chain reaction of defaults. The inefficiency of default spillovers can be corrected by strengthening the enforcement of creditor rights, so that private individual borrowers have less incentives to default, reducing the incidence of systemic default episodes.

The second chapter analyzes the implications of developing financial markets for contingent assets on the degree of risk sharing, the incidence of systemic financial crises and credit externalities through collateral prices in emerging economies with limited access to international capital markets. We find that, in an environment with persistent shocks and collateral constraints, even though agents cannot engage in full risk sharing, access to state contingent assets improves the degree of hedging, reduces the need for precautionary savings and lowers the incidence of financial crises. In addition, it further reduces the spillover effect of credit externalities by dampening the effect of an individual's borrowing on the valuation of collateral of other borrowers.