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This paper expands on the work of Sarno and Taylor (1999) by developing IMF-induced creditor moral hazard models in equity markets under alternative assumptions of market bubbles and implicit guarantees. To do so, it incorporates IMF-related news associated program negotiations and program approval to the models. Using daily stock returns for Indonesia and Korea, we estimate the applicability of these models by estimating changes in stock returns in response to the IMF-related news during the Asian crisis period. The results regarding Korea and, to a lesser extent, Indonesia are consistent with the creditor moral hazard models that assume implicit guarantees and asset price bubbles. However, the results show that the duration of creditor moral hazard in equity markets could be measured only by days, suggesting that it is a short-term phenomenon.

Creditor Moral Hazard in Equity Markets: A Theoretical Framework and Evidence from Indonesia and Korea