Contagion and Volatility with Imperfect Credit Markets
October 1, 1997
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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
Pages:
33
Volume:
1997
DOI:
Issue:
127
Series:
Working Paper No. 1997/127
Stock No:
WPIEA1271997
ISBN:
9781451935967
ISSN:
1018-5941
Notes
Also published in Staff Papers, Vol. 45, No. 2, June 1998.
