IMF Working Papers

Contagion and Volatility with Imperfect Credit Markets

By Joshua Aizenman, Pierre-Richard Agénor

October 1, 1997

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Joshua Aizenman, and Pierre-Richard Agénor. "Contagion and Volatility with Imperfect Credit Markets", IMF Working Papers 1997, 127 (1997), accessed June 19, 2025, https://doi.org/10.5089/9781451935967.001

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper interprets contagion effects as an increase in the volatility of aggregate shocks impinging on the domestic economy. The implications of this approach are analyzed in a model with two types of credit market imperfections: domestic banks borrow at a premium on world capital markets, and domestic producers (whose demand for credit results from working capital needs) borrow at a premium from domestic banks. Higher volatility of producers’ productivity shocks increases both domestic and foreign financial spreads and the producers’ cost of capital, resulting in lower employment and higher incidence of default. Welfare effects are nonlinearly related to the degree of international financial integration.

Subject: Bank credit, Banking, Capital markets, Employment, Financial institutions, Financial markets, Labor, Loans, Money, Production, Productivity

Keywords: Bank closure, Bank credit, Capital markets, Cost of capital, Credit market, Credit market imperfections, Domestic bank, Employment, Enforcement cost, Global, Interest rate spread, Interest rate spreads, Lending rate, Loans, Probability of default, Productivity, Representative bank, Volatility, WP

Publication Details

Notes

Also published in Staff Papers, Vol. 45, No. 2, June 1998.