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

September 1, 2007

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Format: Chicago

Emine Boz. Can Miracles Lead to Crises? the Role of Optimism in Emerging Markets Crises, (USA: International Monetary Fund, 2007) accessed December 22, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Asset prices, Balance of payments, Consumption, Current account, Emerging and frontier financial markets, Financial markets, National accounts, Prices, Production, Productivity

Keywords: Asset demand function, Asset price volatility, Asset prices, Consumption, Consumption display swing, Current account, Demand decrease, Domestic investor, East Asia, Emerging and frontier financial markets, Emerging market, Emerging market asset, Emerging markets, Financial crises, Foreign investor, Informational frictions, Investor confidence, Investors' asset holding, Learning, Productivity, Productivity shock, Sentiment occcur, Trading cost, WP

Publication Details

Pages:

34
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2007/223
Stock No:

WPIEA2007223
ISBN:

9781451867879
ISSN:

1018-5941

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