Financial Globalization, Financial Crises, and the External Portfolio Structure of Emerging Markets

Enrique G. Mendoza and Katherine A. Smith

Scandinavian Journal of Economics, 2014, vol. 116, issue 1, 20-57

Abstract: We study the transitional dynamics of financial integration in emerging economies using a two‐sector model with a collateral constraint on external debt and trading costs incurred by foreign investors. The probability of a financial crisis displays overshooting; it rises sharply initially and then falls sharply, but remains non‐zero in the long run. While equity holdings fall permanently, bond holdings initially fall, but rise after the probability of a crisis peaks. Conversely, asset returns and asset prices first rise and then fall. These results are in line with the post‐globalization dynamics observed in emerging markets, and the higher frequency of crises that they display.

Date: 2014
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