Asset Bubbles, Domino Effects and 'Lifeboats': Elements of the East Asian Crisis

Hali Edison (), Pongsak Luangaram and Marcus Miller ()

No 1866, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Credit market imperfections have been blamed for the depth and persistence of the Great Depression in the US. Could similar mechanisms have played a role in ending the East Asian miracle? After a brief account of the nature of the recent crises, we use Kiyotaki and Moore’s (1997) model of highly levered credit-constrained firms to explore this question. As applied to land-holding property companies, it predicts greatly amplified responses to financial shocks – like the ending of the land price bubble or the fall of the exchange rate. The initial fall in asset values is followed by the ‘knock-on’ effects of the scramble for liquidity as companies sell land to satisfy their collateral requirements – causing land prices to fall further. This could lead to financial collapse where – like falling dominoes – prudent firms are brought down by imprudent firms. Key to avoiding collapse is the nature of financial stabilization policy; in a crisis, temporary financing can prevent illiquidity becoming insolvency and launching ‘lifeboats’ can do the same. But the vulnerability of financial systems, like those in East Asia, to short-term foreign currency exposure suggests that preventive measures are also required.

Keywords: asset price bubbles; Credit Market Imperfections; Financial Crisis; illiquidity and insolvency (search for similar items in EconPapers)
JEL-codes: E32 G21 G32 G33 O54 (search for similar items in EconPapers)
Date: 1998-04
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Working Paper: Asset bubbles, domino effects and 'lifeboats': elements of the East Asian crisis (1998)
Working Paper: Asset Bubbles, Domino Effects and 'Lifeboats': Elements of the East Asian Crisis (1998)
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