The Volatility Machine

Since that is the case, any sovereign borrowing strategy that does not implicitly assume a fairly neutral position about the direction of credit spreads can involve a significant increase in volatility—and hence in the probability of distress.

They occur instead for two other, related, reasons. First, emerging market borrowers and investors have consistently underestimated the source and magnitude of volatility in emerging financial markets. Second, perhaps as a consequence, borrowers and investors have permitted and even encouraged sovereigns to put into place capital structures that sy

The Eurodollar market was the name given to the market surrounding the dollar accumulation in the banking system outside the United States during the “dollar glut” period of low U.S. interest rates in the 1960s.

One problem with most LDC securities markets is that there is a very poor balance of investors.

And as was the case during the Mexican crisis, it required a major lender to provide a liquidity facility to end the vicious circle of liquidating assets, plunging collateral value, and more forced liquidations.

When volatility increases, the negative effect on the already low intrinsic value is less than the positive effect on time value. As volatility increases, consequently, equity value increases.

countries and even regions are subject to market-related risks and shocks that can disrupt their behavior, just as companies are, and these risks are transmitted in the same way: through their capital structures. In fact any economic entity’s capital structure can be seen as a sort of volatility machine, one of whose main functions is precisely to

Volatility itself was an extremely important variable, and to ignore it invalidated much of the analysis.

I will distinguish between economic policy and the transmission of volatility, and I will argue that policy-making must be constructed in an environment in which excess volatility is kept to a minimum.