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Financial Globalization and Emerging Markets: With or Without Crash?

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  • Martin, Philippe
  • Rey, Hélène

Abstract

We analyse the impact of financial globalization on asset prices, investment and the possibility of crashes driven by self-fulfilling expectations in emerging markets. In a two-country model with one emerging market (intermediate income level) and one industrialized country (high income level), we show that symmetric liberalization of capital outflows and inflows increases asset prices, investment and income in the emerging market. For intermediate levels of international financial transaction costs, however, we find that pessimistic expectations can be self-fulfilling, leading to a financial crash. The crash is accompanied by capital flight, a drop in income and investment below the financial autarky level and more market incompleteness. We show that emerging markets are more prone to such a financial crash simply because they have a lower income level and not because of the existence of market failures (moral hazard or credit constraints), bad monetary policies or exchange rate regimes.

Suggested Citation

  • Martin, Philippe & Rey, Hélène, 2002. "Financial Globalization and Emerging Markets: With or Without Crash?," CEPR Discussion Papers 3378, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:3378
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    More about this item

    Keywords

    Financial globalization; Emerging markets; Financial crises;
    All these keywords.

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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