Capital Openness and Financial Crises: A Financial Contagion Model with Multiple Equilibria

Juan Luo and Wenjin Tang

Journal of Economic Policy Reform, 2007, vol. 10, issue 4, 283-296

Abstract: This paper explores the effects of capital openness on financial crises and contagion. In the model, we analyze four channels of contagion involved in the process of financial crisis: monsoon effects, spillovers, self‐fulfilling expectations and new information. We empirically test the data from China, an economy with capital account controls, and find that the fundamentals of China (PRC) are now in a vulnerable area which yields multiple equilibria. Consequently, the Chinese economy is easily affected via the channels discussed in this paper. Finally we suggest that the capital account of China should be opened gradually.

Date: 2007
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DOI: 10.1080/17487870701551972

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