International borrowing without commitment and informational lags: Choice under uncertainty

Abstract

Abstract. A series of recent studies in economic growth theory have considered a class of models of international borrowing where, in the absence of a perfect investment commitment, the borrowing constraint depends on the historical performances of the country. Thus, a better level of past economic activity gives a higher reputation, thereby increasing the possibility of accessing the international credit market. This note considers this problem in a stochastic setting based on the volatility of the internal net capital. We study how the optimal consumption level and the maximal expected welfare depend on the combined influence of the trajectory of past economic variables and the volatile environment. In particular, we show how the strength of the history effect and the relative weight of the historical performance depend on the degree of risk.

Introduction to international financial markets and banking systems crises

“…The analytical cost paid to address this question is the solution of an optimal control problem of a neutral stochastic differential equation, which is in itself an authentic tour de force. Fabbri [20] is then able to show two important results. First of all, the total strength of the history effect (that's the impact of the whole historical data, as determined by the informational lag given, on the optimal path for net capital at any date) is not reduced by the volatile environment.…”

“…Fabbri [20] extends the deterministic framework described just above adding uncertainty on net capital (domestic capital net of foreign debt). The main question is to which extent the history effect highlighted by Boucekkine and Pintus [7] is affected by the exogenous volatility of net capital.…”

“…A new modelling and methodology are under way, and the first paper of this special section, Klimenko et al [29] presents a kind of minimal setting allowing to generate, via endogenous risk mechanisms, the persistence and volatility outcomes imperfectly replicated by the standard real business cycles methodology. The second paper, Fabbri [20], addresses some specific aspects of international borrowing under capital collateral constraints. In particular, it highlights the fact that investment commitment (induced by capital collateral constraints) is hardly credible in an international context because there is no such thing as an international law court to which lenders can resort in case promised investment does not materialize.…”