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We propose that the limited financial development of emerging markets is a significant factor behind the large share of dollar-denominated external debt present in these markets. We show that when financial constraints affect borrowing and lending between domestic agents, agents undervalue insuring against an exchange rate depreciation. Since more of this insurance is present when external debt is denominated in domestic currency rather than in dollars, this result implies that domestic agents choose excessive dollar debt. We also show that limited financial development reduces the incentives for foreign lenders to enter emerging markets. The retarded entry reinforces the underinsurance problems. Keywords: Currency mismatch, balance sheets, international liquidity, contingent credit lines, thin markets, limited participation. JEL Classification: F300, F310, F340 G150, G380.
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Excessive dollar debt: financial development and underinsurance
2002, Massachusetts Institute of Technology, Dept. of Economics
in English
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"March 2002."; "March 1, 2002"--Abstract.
Includes bibliographical references (p. 28-29).
Abstract in HTML and working paper for download in PDF available via World Wide Web at the Social Science Research Network.
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