The Volatility Machine

One way of thinking about this is that the more the expected variation in the net flows (i.e., inflows minus outflows), the more volatile a capital structure is.

The magnitude of the crisis, in other words, largely reflects the capital structure of the affected economy,

corporations; I mean the body of finance theory that applies to the relationship between an economic entity, its capital structure, and market risks.

Here the basic assumption is that capital inflows precede and cause growth.

Rather it is to address directly the instability that is introduced through the mismatched capital structure.

it does so when the borrower is best able to handle the higher cost.

this book I will argue that certain types of financial crises—like the crises that have affected many Latin American and Asian countries in recent years—are problems of sovereign balance sheet mismanagement and not economic mismanagement.

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