We present a novel explanation for the prevalence of foreign-currency borrowing in emerging markets. First, under limited liability, foreign-currency denominated debt acts as a state-contingent claim: Borrowers maximizing profits in local currency are partly shielded from large devaluations through bankruptcy, when repaying foreign currency debt is expensive, but pay higher rates in non-devaluation states, when repayment is relatively cheaper. Second, foreign- currency borrowing can improve firms’ incentives and reduce agency problems at the cost of higher systemic risk. The resulting trade-off between average performance and systemic stability, which becomes stronger when bankruptcies entail externalities, lends support to regulation limiting currency mismatches.
- Paper
- Start date: 2019-03-12 11:00:00
- End date: 2019-03-12 12:30:00
- Venue: 1011 Evans Hall
- Address: 1011 Evans Hall, Berkeley, CA, 94720