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Essays on financial crises in emerging markets

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  • Komulainen, Tuomas

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    (Bank of Finland Research)

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    Abstract

    The financial crises in emerging markets in 1997-1999 were preceded by financial liberalisation, rapid surges in capital inflows, increased levels of indebtedness, and then sudden capital outflows. The study contains four essays that extend the different generations of crisis literature and analyse the role of capital movements and borrowing in the recent crises. Essay 1 extends the first generation models of currency crises. It analyses bond financing of fiscal deficits in domestic and foreign currency, and compares the timing and magnitude of attack with the basic case where deficits are monetised. The essay finds that bond financing may not delay the crisis. But if the country’s indebtedness is low, the crisis is delayed by bond financing, especially if the borrowing is carried out with bonds denominated in foreign currency. Essay 2 extends the second generation model of currency crises by adding capital flows. If these depend negatively on crisis probability, there will be multiple equilibria. The range of country fundamentals for which self-fulfilling crises are possible is wider when capital flows are included, and thus more countries may end up in crisis. An application of the model shows that in 1996 in many emerging economies the fundamentals were inside the range of multiple equilibria and hence self-fulfilling crises were possible. Essay 3 studies financial contagion and develops a model of the international financial system. It uses a basic model of financial intermediation, but adds several local banks and an international bank. These banks are able to use outside borrowing, the amount of which is determined by the value of their collateral. The essay finds that the use of leverage by local and global banks and the fall in collateral prices comprise an important channel and reason for contagion. Essay 4 analyses the causes of financial crises in 31 emerging market countries in 1980–2001. A probit model is estimated using 23 macroeconomic and financial sector indicators. The essay finds that traditional variables (eg unemployment and inflation) and several indicators of indebtedness (eg private sector liabilities and banks' foreign liabilities) explain currency crises. When the sample was divided into pre- and post-liberalisation periods, the indicators of indebtedness became more important in predicting crisis in the postliberalisation period.

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    Bibliographic Info

    Paper provided by Bank of Finland in its series Scientific Monographs with number E:29/2004.

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    Length: 180 pages
    Date of creation: 11 Nov 2004
    Date of revision:
    Handle: RePEc:hhs:bofism:2004_029

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    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Related research

    Keywords: currency crises; banking crises; emerging markets; borrowing; collateral; contagion; liberalisation;

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    1. Reinhart, Carmen & Kaminsky, Graciela, 1998. "Financial crises in Asia and Latin America: Then and now," MPRA Paper 13877, University Library of Munich, Germany.
    2. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June.
    3. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. V�gh, 2003. "The Unholy Trinity of Financial Contagion," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 51-74, Fall.
    4. Kaminsky, Graciela & Lizondo, Saul & Reinhart, Carmen M., 1997. "Leading indicators of currency crises," Policy Research Working Paper Series 1852, The World Bank.
    5. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1993. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 108-151, March.
    6. Carmen M. Reinhart & Kenneth S. Rogoff, 2002. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," NBER Working Papers 8963, National Bureau of Economic Research, Inc.
    7. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
    8. Morris Goldstein & Carmen M. Reinhart, 2000. "Assessing Financial Vulnerability: An Early Warning System for Emerging Markets," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 100, July.
    9. Reinhart, Carmen & Calvo, Guillermo, 2000. "When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options," MPRA Paper 6982, University Library of Munich, Germany.
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