Capital markets have witnessed a rash of `Sudden Stops' during the last decade.Policy proposals to prevent these crises include creating indexed bond markets andproviding price guarantees for emerging market assets. Chapter 1 explores themacroeconomic implications of indexed bonds with a return indexed to the keyvariables driving emerging market economies such as terms of trade or productivity.We employ a quantitative model of a small open economy in which Sudden Stops aredriven by the financial frictions inherent to world capital markets. While indexedbonds provide a hedge to income fluctuations and can undo the effects of financialfrictions, they lead to interest rate fluctuations. Due to this tradeoff, there exists anon-monotonic relation between the "degree of indexation" (i.e., the percentage ofthe shock reflected in the return) and the overall effects of these bonds on macroe-conomic fluctuations. Therefore, indexation can improve macroeconomic conditionsonly if the degree of indexation is less than a critical value. When the degree ofindexation is higher than this threshold, it strengthens the precautionary savingsmotive, increases consumption volatility and impact effect of Sudden Stops. Thethreshold degree of indexation depends on the volatility and persistence of incomeshocks as well as the relative openness of the economy.Chapter 2 explores the implications of asset price guarantees provided by aninternational financial organization on the emerging market assets. This policy ismotivated by the globalization hazard hypothesis, which suggest that Sudden Stopscaused by global financial frictions could be prevented by offering foreign investorsprice guarantees on emerging markets assets. These guarantees create a trade-off, however, because they weaken globalization hazard while creating internationalmoral hazard. We study this tradeoff using a quantitative, equilibrium asset-pricingmodel. Without guarantees, margin calls and trading costs cause Sudden Stopsdriven by a Fisherian deflation. Price guarantees prevent this deflation by proppingup foreign demand for assets. The effectiveness of price guarantees, their distor-tions on asset markets, and their welfare implications depend critically on whetherthe guarantees are contingent on debt levels and on the price elasticity of foreigndemand for domestic assets.
