The first part of this thesis examines the role of highly-leveraged institution in creating vulnerability in the financial system. By applying the framework of Kiyotaki and Moore (1997), Chapter 2 shows that when an asset price bubble bursts which cuts the value of land being used as collateral, the sudden fall in collateral value can create the possibility that firms’ net worth is entirely wiped out and the whole financial system collapse. This is due to the powerful feedback effects where forced selling further depresses prices, setting in motion a downward spiral of asset prices and loan recalls. We then show how wholesale financial collapse can be avoided by co-ordinated loan roll-overs in the form of a general financial freeze; and how the breathing space gained in this way can be used to arrange for loan write-downs or capital injections. In Chapter 3, the degree of corporate leverage is analysed more explicitly by introducing margin requirements into the model and two types of adverse shocks are examined numerically, an asset bubble bursting and a sudden rise in real interest rates. We find that when the economy is highly leveraged, a small shock to real interest rates can have powerful impacts on asset prices and cause widespread bankruptcy of the credit-constrained sector. To shed light on the recent debate on the role of prudential regulatory policies in mitigating the impact of a bubble bursting, we show that relaxing margin requirements can be used as a form of ‘regulatory forbearance’ for avoiding and/or reducing the knock-on effects.\ud \ud The second part of the thesis is a case study of Thailand. Chapter 4 provides a detailed account of Thailand economic developments from 1988 to 1998; it is argued that the nature of Thai financial crisis lied in the profound boom and burst in real estate sector which played a central role in creating tensions in the financial system and ultimately causing severe contraction of the economic activity. Chapter 5 explores some key issues relating to systemic bankruptcy of the corporate sector in aftermath of the Thai crisis
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