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

Emine Boz

No 2007/223, IMF Working Papers from International Monetary Fund

Abstract: Emerging market financial crises are abrupt and dramatic, usually occurring after a period of high output growth, massive capital flows, and a boom in asset markets. This paper develops an equilibrium asset-pricing model with informational frictions in which vulnerability and the crisis itself are consequences of the investor optimism in the period preceding the crisis. The model features two sets of investors, domestic and foreign. Both sets of investors learn from noisy signals, which contain information relevant for asset returns and formulate expectations, or "beliefs," about the state of productivity. We show that, if preceded by a sequence of positive signals, a small, negative noise shock can trigger a sharp downward adjustment in investors' beliefs, asset prices, and consumption. The magnitude of this downward adjustment and sensitivity to negative signals increase with the level of optimism attained prior to the negative signal.

Keywords: WP; emerging market; financial crises; emerging markets; informational frictions; learning; investors' asset holding; asset demand function; emerging market asset; consumption display swing; investor confidence; trading cost; demand decrease; asset price volatility; domestic investor; foreign investor; productivity shock; sentiment occcur; Asset prices; Productivity; Consumption; Emerging and frontier financial markets; Current account; East Asia (search for similar items in EconPapers)
Pages: 34
Date: 2007-09-01
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Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Can Miracles Lead to Crises? The Role of Optimism in Emerging Markets Crises (2009)
Journal Article: Can Miracles Lead to Crises? The Role of Optimism in Emerging Markets Crises (2009)
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