A MODEL OF SELF‐FULFILLING FINANCIAL CRISES*

Yong Jin Kim and Jong-Wha Lee

The Japanese Economic Review, 2006, vol. 57, issue 1, 87-100

Abstract: This paper combines the structural weakness and the self‐fulfilling panic view to explain the cause of the East Asian crises. In this model economy, the diversification strategies induce conglomerate firms to overinvest. They accumulate losses due to their unprofitable sectors and then compensate by obtaining bank loans. Domestic banks, which borrow from foreign banks, lend money as long as the total amount of accumulated loans remains within the firms’ collateral value. The model shows that if the debt to collateral value ratio belongs to a certain range a self‐fulfilling crisis can occur due to the self‐fulfilling expectations of foreign investors.

Date: 2006
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