Speculative behaviour, debt default and contagion : a stylised framework of the Latin American crisis 2001-2002

Release date
01/12/2003
Reference
DP2003/10
Author
Louise Allsopp
This paper provides a model incorporating strategic speculative behaviour into a framework of debt default and contagion. A basic model of contagion shows how economies which appear fundamentally sound, can fail to meet foreign obligations when there are inter-linkages with a defaulting country. Introducing speculators into the framework increases the incidence of debt default and contagion. However, when these speculators view the economy with a degree of uncertainty, the likelihood of default and contagion is even greater. Speculators' perceptions over the state of the economy are therefore paramount when estimating the impact of a crisis on a region.