Sudden Stop crises in economies with heterogeneous agents

This paper studies the cross-sectional implications of borrowing decisions in the presence of a Sudden Stop crisis – a period of large capital outflows. I develop an Aiyagari-Bewley type heterogeneous agent open economy model in which agents face uninsurable idiosyncratic and aggregate endowment shocks. Agents are endowed with risky endowments of tradable and non-tradable goods. The aggregate shocks affect the total endowment of both goods while the idiosyncratic shocks determine the endowment composition. Agents do not internalise the effect of their decisions on the relative price of non-tradable goods which leads to an unexpected tightening of the collateral constraint. The results show that the Sudden Stop crises severity is lower compared to the representative agent case. It can be explained by the wealthy agents less exposed to the exchange rate risk, and by the precautionary savings accumulated by all agents as a reaction to uninsurable idiosyncratic risk. Therefore, heterogeneity helps to dampen the effects of the crisis.