Financial Globalization and Emerging Markets: With or Without Crash?

Philippe Martin and Helene Rey

No 3378, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We analyse the impact of financial globalization on asset prices, investment and the possibility of crashes driven by self-fulfilling expectations in emerging markets. In a two-country model with one emerging market (intermediate income level) and one industrialized country (high income level), we show that symmetric liberalization of capital outflows and inflows increases asset prices, investment and income in the emerging market. For intermediate levels of international financial transaction costs, however, we find that pessimistic expectations can be self-fulfilling, leading to a financial crash. The crash is accompanied by capital flight, a drop in income and investment below the financial autarky level and more market incompleteness. We show that emerging markets are more prone to such a financial crash simply because they have a lower income level and not because of the existence of market failures (moral hazard or credit constraints), bad monetary policies or exchange rate regimes.

Keywords: Financial globalization; Emerging markets; Financial crises (search for similar items in EconPapers)
JEL-codes: F32 F36 F41 (search for similar items in EconPapers)
Date: 2002-05
New Economics Papers: this item is included in nep-ifn and nep-rmg
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Citations: View citations in EconPapers (41)

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