This paper shows that the quantitative predictions of an equilibrium asset pricing model with financial frictions are consistent with the large consumption and current-account reversals and asset-price collapses observed in the "Sudden Stops" of emerging markets crises. Margin requirements set a collateral constraint on foreign borrowing by domestic agents. Foreign traders incur costs in trading assets with domestic agents. Margin constraints bind occasionally depending on equilibrium portfolios and asset prices. When the constraints do not bind, productivity shocks cause standard real-business-cycle effects. When the constraints bind, shocks of the same magnitude cause strikingly different effects that vary with the leverage ratio and the liquidity of asset markets. With high leverage and liquid markets, the shocks trigger margin calls forcing "fire sales" of assets. Fisher's debt-deflation mechanism causes subsequent rounds of margin calls, a fall in asset prices and large consumption and current account reversals. The size of the price decline depends on trading costs parameters because these parameters determine the price elasticity of the foreign traders' asset demand function. Price declines of the magnitude observed in the data require a less-than-unitary price elasticity. Precautionary saving makes Sudden Stops infrequent in the long run so that the model can explain both regular business cycles and the unusually large reversals of consumption and current accounts associated with Sudden Stops.
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Length: Date of creation: Dec 2004 Date of revision: Handle: RePEc:nbr:nberwo:10940
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Find related papers by JEL classification: F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
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Kiyotaki, Nobuhiro & Moore, John, 1997.
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Other versions:
Nobuhiro Kiyotaki & John Moore, 1995.
"Credit Cycles,"
NBER Working Papers
5083, National Bureau of Economic Research, Inc.
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John Moore & Nobuhiro Kiyotaki, .
"Credit Cycles,"
Discussion Papers
1995-5, Edinburgh School of Economics, University of Edinburgh.
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