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

Enrique Mendoza and Katherine Smith

No 19072, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study the short- and long-run effects 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 positive in the long run. While equity holdings fall permanently, bond holdings initially fall but rise after the crisis probability 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 they displayed. Without financial frictions, the model yields a negligible fall in equity and a large increase in debt. The results also depend critically on supply-side effects of financial frictions affecting the price of nontradables and dividends from nontradables producers, and on strong precautionary savings incentives induced by the risk of financial crises.

JEL-codes: D52 E44 F32 F41 (search for similar items in EconPapers)
Date: 2013-05
New Economics Papers: this item is included in nep-dge and nep-opm
Note: IFM
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Published as Enrique G. Mendoza & Katherine A. Smith, 2014. "Financial Globalization, Financial Crises, and the External Portfolio Structure of Emerging Markets," Scandinavian Journal of Economics, Wiley Blackwell, vol. 116(1), pages 20-57, 01.

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