Bubbles and capital flow volatility: Causes and risk management
AbstractEmerging market economies are fertile ground for the development of real estate and other financial bubbles. Despite these economies' significant growth potential, their corporate and government sectors do not generate the financial instruments to provide residents with adequate stores of value. Capital often flows out of these economies seeking these stores of value in the developed world. Bubbles are beneficial because they provide domestic stores of value and thereby reduce capital outflows while increasing investment. But they come at a cost, as they expose the country to bubble-crashes and capital flow reversals. We show that domestic financial underdevelopment not only facilitates the emergence of bubbles, but also leads agents to undervalue the aggregate risk embodied in financial bubbles. In this context, even rational bubbles can be welfare reducing. We study a set of aggregate risk management policies to alleviate the bubble-risk. We show that liquidity requirements, sterilization of capital inflows and structural policies aimed at developing public debt markets "collateralized" by future revenues, all have a high payoff in this environment.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Monetary Economics.
Volume (Year): 53 (2006)
Issue (Month): 1 (January)
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Web page: http://www.elsevier.com/locate/inca/505566
Other versions of this item:
- Ricardo J. Caballero & Arvind Krishnamurthy, 2005. "Bubbles and Capital Flow Volatility: Causes and Risk Management," NBER Working Papers 11618, National Bureau of Economic Research, Inc.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
- F34 - International Economics - - International Finance - - - International Lending and Debt Problems
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
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