Emerging Market Lending: Is Moral Hazard Endogenous?

Tobias Broer

No 35, Royal Economic Society Annual Conference 2002 from Royal Economic Society

Abstract: This paper looks at the effect of moral hazard, resulting from information asymmetries in financial markets, on growth in financially open developing countries. We show that if domestic entrepreneurs can gamble with foreign creditors' money, borrowing under standard debt contracts is constrained by a No-Gambling Condition similar to that of Hellmann, Murdock, and Stiglitz (2000). However, this incentive constraint is endogenous in the development process: growth increases entrepreneurs' own capital at risk, thus reducing gambling incentives, but it decreases profitability of capital investment, which has the opposite effect. General equilibrium under moral hazard shows a unique and stable steady state, but involves at least temporary rationing of profitable projects and possibly capital flight from developing countries.

Date: 2002-08-29
New Economics Papers: this item is included in nep-ent, nep-fmk and nep-mfd
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Related works:
Journal Article: EMERGING MARKET LENDING: IS MORAL HAZARD ENDOGENOUS? (2007)
Working Paper: Emerging Market Lending: Is Moral Hazard Endogenous? (2004)
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