Working Paper: NBER ID: w7389
Authors: Joshua Aizenman; Nancy Marion
Abstract: We show that increased uncertainty about the size of an emerging market's external debt has a nonlinear and potentially large adverse effect on the supply of international credit offered to them. We also show that if international creditors are first- order risk averse, attaching greater weight to utility derived from bad outcomes than from good ones, a moderate increase in uncertainty about debt overhang or about other relevant factors affecting repayment prospects-- can cause the supply of credit to dry up completely. We therefore offer one possible explanation for why emerging markets may find themselves suddenly cut off from international capital markets.
Keywords: international credit; emerging markets; debt overhang; risk aversion
JEL Codes: F2; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased uncertainty about the size of an emerging market's external debt (F65) | Adverse effect on the supply of international credit (F65) |
| Increased uncertainty about debt overhang (F65) | Credit supply dries up completely (E51) |
| Moderate increases in uncertainty (D89) | Complete withdrawal of credit supply (E51) |
| Heightened uncertainty (D89) | Reevaluation of risk by investors (G11) |
| Reevaluation of risk by investors (G11) | Liquidity shortage for emerging markets during crises (F65) |
| Upward revisions of reported external debt (F34) | Increased investor pessimism (G41) |
| Increased investor pessimism (G41) | Collapse in credit availability (F65) |