Identifying the role of moral hazard in international financial markets

Steven B. Kamin

No 736, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: Considerable attention has been paid to the possibility that large-scale IMF-led financing packages may have distorted incentives in international financial markets, leading private investors to provide more credit to emerging market countries, and at lower interest rates, than might otherwise have been the case. Yet, prior attempts to identify such distortions have yielded mixed evidence, at best. This paper makes three contributions to our ability to assess the empirical importance of moral hazard in international financial markets. First, it is argued that because large international \"bailouts\" did not commence until the 1995 Mexican crisis, financial indicators prior to that time could not have reflected a significant degree of this type of moral hazard. Therefore, one test for the existence of moral hazard is that the access of emerging markets to international credit is significantly easier than it was prior to 1995. Second, the paper argues that because private investors expect large-scale IMF-led packages to be extended primarily to economically or geo-politically important countries, moral hazard, if it exists, should lead these countries to have easier terms of access to credit than smaller, non-systemically important countries. Finally, in addition to looking at bond spreads, the focus of earlier empirical analyses of moral hazard, the paper also examines trends in capital flows to gauge the access of emerging market countries to external finance. Looking at the evidence in light of these considerations, the paper concludes that there is little support for the view that moral hazard is significantly distorting international capital markets at the present time.

Keywords: Financial markets; Developing countries (search for similar items in EconPapers)
Date: 2002
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-ifn
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Citations: View citations in EconPapers (18)

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