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Private Inflows when Crises are Anticipated: A Case Study of Korea

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Michael P. Dooley
Inseok Shin

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Abstract

Models of financial crises based on distortions in capital markets have strong implications for the behavior of investors leading up to crises. In this paper we evaluate the hypothesis that deregulation of financial markets in Korea provided the incentives and opportunities for a sequence of capital inflows and crisis. We show that deregulation was associated with a sharp declines in the franchise value of Korean banks. Banks responded by expanding their balance sheets and accumulating high risk, high return assets. The regulatory mechanism appears to have failed because of the failure to consolidate onshore and offshore activities of banks. Foreign banks that supplied deposits to Korean banks behaved as if they were insured in that they did not discriminate between weak and strong Korean banks. Finally, this expectation was validated at the time of crisis by government intervention that allowed foreign banks to liquidate their claims on Korean banks.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7992.

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Date of creation: Nov 2000
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Handle: RePEc:nbr:nberwo:7992

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Diaz-Alejandro, Carlos, 1985. "Good-bye financial repression, hello financial crash," Journal of Development Economics, Elsevier, vol. 19(1-2), pages 1-24. [Downloadable!] (restricted)
  2. Ilan Goldfajn & Rodrigo Valdés, 1997. "Balance of Payments Crises and Capital Flows: The Role of Liquidity," Working Papers Central Bank of Chile 11, Central Bank of Chile. [Downloadable!]
  3. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November. [Downloadable!] (restricted)
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  4. Stanley Fischer, 1999. "On the Need for an International Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 85-104, Fall. [Downloadable!] (restricted)
  5. Gerald Caprio & Michael Dooley & Danny Leipziger & Carl Walsh, 1996. "The lender of last resort function under a currency board: The case of Argentina," Open Economies Review, Springer, vol. 7(1), pages 625-650, March. [Downloadable!] (restricted)
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  6. 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.). [Downloadable!]
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  7. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August. [Downloadable!] (restricted)
  8. Barry Eichengreen & Charles Wyplosz, 1993. "The Unstable EMS," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(1993-1), pages 51-144. [Downloadable!]
  9. Dooley, Michael P, 2000. "A Model of Crises in Emerging Markets," Economic Journal, Royal Economic Society, vol. 110(460), pages 256-72, January. [Downloadable!] (restricted)
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  1. Joshua Aizenman, 2004. "Financial Opening: Evidence and Policy Options," NBER Chapters, in: Challenges to Globalization: Analyzing the Economics, pages 473-498 National Bureau of Economic Research, Inc. [Downloadable!]
    Other versions:
  2. Thomas D. Willett, 2001. "Truth in Advertising and The Great Dollarization Scam," Claremont Colleges Working Papers 2001-05, Claremont Colleges. [Downloadable!]
  3. Tobias Knedlik & Johannes Stöbel, 2006. "The role of banking portfolios in the transmission from currency crises to banking crises - potential effects of Basel II," IWH Discussion Papers 21-06, Halle Institute for Economic Research. [Downloadable!]
  4. Timothy Chue & David Cook, 2004. "Sudden Stops and Liability Dollarization: Evidence from East Asian Financial Intermediaries," Econometric Society 2004 Far Eastern Meetings 646, Econometric Society. [Downloadable!]
  5. Thomas D. Willett & Aida Budiman & Arthur Denzau & Gab-Je Jo & Cesar Ramos & John Thomas, 2001. "The Falsification of Four Popular Hypotheses about International Financial Behavior during the Asian Crisis," Claremont Colleges Working Papers 2001-06, Claremont Colleges, revised Sep 2001. [Downloadable!]
  6. Bems, Rudolfs & Jönsson, Kristian, 2002. "Financial Crisis in Emerging Markets and the Optimal Bailout Policy," Working Paper Series in Economics and Finance 520, Stockholm School of Economics, revised 31 Oct 2003. [Downloadable!]
  7. Douglas W. Diamond & Raghuram G. Rajan, 2000. "Banks, Short Term Debt and Financial Crises: Theory, Policy Implications and Applications," NBER Working Papers 7764, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Janet L. Yellen, 2007. "The Asian financial crisis ten years later: assessing the past and looking to the future," Speech, Federal Reserve Bank of San Francisco, issue Feb 6. [Downloadable!]
  9. Joshua Aizenman, 2009. "Financial Crisis and the Paradox of Under- and Over-Regulation," NBER Working Papers 15018, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  10. Thomas D. Willett & Nancy Neiman Auerbach, 2002. "The Political Economy of Perverse Financial Liberalization: Examples from the Asian Crisis," Claremont Colleges Working Papers 2002-26, Claremont Colleges. [Downloadable!]
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