Asset Prices, Collateral Constraints and Balance-of-Payments Crises

Emerging markets crises experience shows that asset prices decline in advance of balance-of-payments crises, and that firms face credit constraints during crises. This paper presents a model where an anticipated balance-of-payments crisis causes asset prices to decline that in turn trigger firms' collateral constraints to bind. With collateral constraints, self-fulfilling crisis equilibria are shown to exist even when there are no government bailouts. The time of the self-fulfilling run on foreign reserves is mapped with its initial level and the degree of government bailout. Without government bailout, the time of the run conforms to the conventional wisdom: the higher the level of foreign reserves, the later is the crisis. With bailouts, however, this relationship is non-monotonic. When government bailouts are large, the higher the level of foreign reserves, the sooner is the crisis.