Can Miracles Lead to Crises? An Informational Frictions Explanation of Emerging Markets Crises

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 are imperfectly informed about the true state of the emerging economy. Investors learn from noisy signals which contain information relevant for asset returns and formulate expectations, or ``beliefs'', about the state of productivity. Numerical analysis shows 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. Moreover, with the introduction of informational frictions, asset prices display persistent effects in response to transitory shocks, and the volatility of consumption increasesfinancial crises, emerging markets, informational frictions, learning

Do Miracles Lead to Crises?: An Informational Frictions Explanation to Emerging Market Financial Crises

financial crises, emerging markets, informational frictions, signal extraction

Financial Innovation, the Discovery of Risk, and the U.S. Credit Crisis

Financial innovation and overconfidence about asset values and the riskiness of new financial products were important factors behind the U.S. credit crisis. We show that a boom-bust cycle in debt, asset prices and consumption characterizes the equilibrium dynamics of a model with a collateral constraint in which agents learn \by observation" the true riskiness of a new financial environment. Early realizations of states with high ability to leverage assets into debt turn agents overly optimistic about the persistence probability of a high-leverage regime. Conversely, the first realization of a low-leverage state turns agents unduly pessimistic about future credit prospects. These effects interact with the Fisherian deflation mechanism, resulting in changes in debt, leverage, and asset prices larger than predicted under either rational expectations without learning or with learning but without Fisherian deflation. The model predicts a large, sustained increase in net household debt and in residential land prices between 1997 and 2006, followed by a sharp collapse in 2007.

Emerging Market Business Cycles Revisited: Learning about the Trend

We build an equilibrium business cycle model in which agents cannot perfectly distinguish between the permanent and transitory components of TFP shocks and learn about those components using the Kalman filter. Calibrated to Mexico, the model predicts a higher variability of consumption relative to output and a strongly negative correlation between the trade balance and output for a wide range of variability and persistence of permanent shocks vis-a-vis the transitory shocks. Moreover, our estimation for Mexico and Canada suggests more severe informational frictions in emerging markets than in developed economies.emerging markets, business cycles, learning, Kalman filter

Informational Frictions and Learning in Emerging Markets

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 thesis 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 are imperfectly informed about the true state of the emerging economy. Investors learn from noisy signals which contain information relevant for asset returns and formulate expectations, or "beliefs", about the state of productivity. Numerical analysis shows 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. The model calibrated to a typical emerging market economy, Turkey, reveals that with the introduction of incomplete information asset prices display persistent effects in response to transitory shocks, and the volatility of consumption increases by 2.1 percentage points. The maximum likelihood estimation of the model's parameters using U.S. data documents that the estimated signal-to-noise ratio for the U.S. is higher since, unlike Turkey, a significantly higher portion of fluctuations can be accounted for by changes in the persistent component rather than the noise. Feeding these two different signal-to-noise ratios to the model, we find that the booms and busts driven by misperceptions of the investors have significantly lower frequency, magnitude, and duration in the case of U.S. compared to Turkey

Health Status, Insurance, and Expenditures in the Transition from Work to Retirement

This paper analyzes the dynamics of health insurance coverage, health expenditures, and health status in the decade expanding from 1992 to 2002, for a cohort of older Americans. We follow 13,594 individuals interviewed in Waves 1 to 6 of the Health and Retirement Study, most of whom were born between 1930 and 1940, as they transition from work into retirement. Although this “depression cohort” is by and large fairly well prepared for retirement in terms of pension coverage and savings, we identify significant gaps in their health insurance coverage, especially among the most disadvantaged members of this cohort. We find that government health insurance programs—particularly Medicare and Medicaid—significantly reduce the number of individuals who are uninsured and the risks of large out of pocket health care costs. However, prior to retirement large numbers of these respondents were uninsured, nearly 18% at the first survey in 1992. Moreover, a much larger share, about 55% of this cohort, are transitorily uninsured, that is, they experience one or more spells, lasting from several months to several years, without health insurance coverage. We also identify a much smaller group of persistently uninsured individuals, and show that this group has significantly less wealth, and higher rates of poverty, unemployment, and health problems, disability, and higher mortality rates than the rest of the members of the cohort under study. We provide evidence that lack of health insurance coverage is correlated with reduced utilization of health care services; for example, respondents with no health insurance visit the doctor one fourth as often as those with private insurance and are also more likely to report declines in health status. We also analyze the components of out of pocket health care costs, and show that prescription drug costs constituted a rapidly rising share of the overall cost of health care during the period of analysis.

Technological Revolutions and Debt Hangovers: Is There a Link?

Abstract The Great Recession, the Great Depression, and the Japanese slump of the 1990s were all preceded by periods of major technological innovation. In an attempt to understand these facts, we estimate a model with noisy news about the future. We find that beliefs about long run income adjust with an important delay to shifts in trend productivity. This delay, together with estimated shifts in the trend of productivity in the three cases, are able to tell a common and simple story for the observed dynamics of productivity and consumption on a 20 to 25 year window. Our analysis highlights the advantages of a look at this data from the point of view of the medium run

Sovereign Default, Private Sector Creditors and the IFIs

This paper builds a model of a sovereign borrower that has access to credit from private sector creditors and an IFI. Private sector creditors and the IFI offer different debt contracts that are modelled based on the institutional frameworks of these two types of debt. We analyze the decisions of a sovereign on how to allocate its borrowing needs between these two types of creditors, and when to default on its debt to the private sector creditor. The numerical analysis shows that, consistent with the data; the model predicts countercyclical IFI debt along with procyclical commercial debt flows, also matching other features of the data such as frequency of IFI borrowing and mean IFI debt stock.Emerging markets;Borrowing;External debt;Economic models;debt, commercial debt, creditors, interest, private sector creditors, sovereign debt, debt flows, creditor, defaults, private sector creditor, loans, debt service, debt stock, commercial borrowing, repayment, balance of payments, payments, sovereign default, private sector debt, debt renegotiation, debt ratios, sovereign borrower, private creditors, commercial credit, debt data, obligations, debt contracts, repudiation, debt obligations, commercial creditors, default risk, credit risk, debt forgiveness, bond yields, debt crises, amount of debt, overdue obligations, reserve holding, market debt, restructuring, access to credit, credit market, creditors data, net debt, sovereign bonds, current account, debt intolerance, general resources account, debt repayment, international lending, bailouts, reserve accumulation, net debtor, reserve management, debts, sovereign defaults

Sovereign default, private sector creditors, and the IFIs

The data reveal that emerging market sovereign borrowing from International Financial Institutions (IFIs) is small, intermittent and countercyclical compared to that from private sector creditors. The IFI loan contracts offered to sovereigns differ from the private ones in that they are more enforceable and have conditionality arrangements attached to them. Taking these contractual differences as given, this paper builds a quantitative model of a sovereign borrower and argues that better enforceability of IFI loan contracts is the main institutional feature that explains the size and cyclicality while conditionality accounts for the intermittency of borrowing from the IFIs.Emerging markets Sovereign debt and default IFIs