Financing decisions of firms and central bank policy

Abstract

This paper aims to explain the sharp rise in unhedged foreign borrowing by South East Asian corporations in the few years prior to the crisis despite remarkably little change in fundamentals. The crucial element of our story is the strategic interaction between firms and the central bank, which gives rise to multiple equilibria: when firms use foreign borrowing, they raise the cost of devaluation to the central bank, which in turn makes foreign borrowing more attractive. Consequently, a small shock to fundamentals may have a large and permanent effect on the equilibrium composition of firms' borrowing.foreign borrowing; Asian crisis