Can Miracles Lead to Crises? The Role of Optimism in Emerging Markets Crises

Emine Boz

Journal of Money, Credit and Banking, 2009, vol. 41, issue 6, pages 1189-1215

Abstract: Emerging market financial crises are abrupt and dramatic usually occurring after a precrisis bonanza. This paper develops an equilibrium asset pricing model with informational frictions in which crisis itself is a--"consequence"--of the investor optimism in the period preceding the crisis. If preceded by a sequence of positive signals, a small, negative noise shock can trigger a downward adjustment in investors' beliefs, asset prices, and consumption. The magnitude of this downward adjustment--"increases"--with the level of optimism attained prior to the negative signal. Moreover, with informational frictions, asset prices display persistent effects in response to transitory shocks. Copyright (c) 2009 The Ohio State University.

Date: 2009

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