Modeling Financial Fragility in Transition Economies

38 Pages Posted: 18 Oct 1999

See all articles by Jeffrey H. Nilsen

Jeffrey H. Nilsen

American University in Bulgaria

Riccardo Rovelli

University of Bologna - Department of Economics; IZA Institute of Labor Economics

Date Written: July 27, 1999

Abstract

Capital inflows have an enormous importance in the financing of investment in emerging and transition economies. However short-term inflows, intermediated by the banking sector of the emerging economy, may be subject to early withdrawals. We model a situation where such withdrawals are motivated by a change in either the domestic or the foreign fundamentals. We show that, for a given change in fundamentals, a reversal in the capital flows (and hence a currency crisis) is more likely the more risk averse are the foreign investors into the emerging economy. We also show that a policy to tax early withdrawals may discourage capital inflows which are more likely to give rise to fundamental runs, by helping to select relatively less risk averse investors. However, such a policy would have to be fine tuned in order not to discourage all capital inflows.

JEL Classification: G21, G28, O16, 023

Suggested Citation

Nilsen, Jeffrey H. and Rovelli, Riccardo, Modeling Financial Fragility in Transition Economies (July 27, 1999). Available at SSRN: https://ssrn.com/abstract=177469 or http://dx.doi.org/10.2139/ssrn.177469

Jeffrey H. Nilsen

American University in Bulgaria ( email )

Blagoevgrad, 2700
Bulgaria
073888489 (Phone)

Riccardo Rovelli (Contact Author)

University of Bologna - Department of Economics ( email )

Strada Maggiore 45
Bologna, 40125
Italy
+39 051 2092 601 (Phone)
+39 051 6402 664 (Fax)

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

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