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Stochastic Optimal Control, International Finance, and Debt Crises$
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Jerome L. Stein

Print publication date: 2006

Print ISBN-13: 9780199280575

Published to Oxford Scholarship Online: May 2006

DOI: 10.1093/0199280576.001.0001

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Country default risk in emerging markets 1

Country default risk in emerging markets 1

(p.191) 7 Country default risk in emerging markets1
Stochastic Optimal Control, International Finance, and Debt Crises

Jerome L. Stein (Contributor Webpage)

Oxford University Press

Early Warning Signals of a default or debt crisis are derived by drawing upon the stochastic optimal control model of an optimal and excessive short-term debt developed in chapter 2. Operational benchmarks for optimal foreign debt and a quantitative measure of the maximum debt which will not be defaulted in the event of adverse shocks are established. Insofar as the actual debt exceeds the benchmark, there is an excess debt, the risk of default is increased. Two sets of emerging market countries are considered: one set renegotiated/defaulted and the other set did not. The countries that defaulted/renegotiated had significant excess debt, whereas the countries that did not default/renegotiate did not have significant excess debt. An Early Warning Signal of a debt crisis is the excess debt, and not the level of the debt/GDP ratio per se.

Keywords:   emerging market, default risk, optimal debt, warning signals, defaults, debt crises, stochastic optimal control, financial market surveillance, credit risk, short-term capital movements

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