Foreign Capital Inflow and Financial Crisis in a Dynamic Model
Posted: 30 Jun 2015
Date Written: June 11, 2015
The paper models foreign capital inflow in a multi-period framework from the developed to the developing countries. The market for foreign loan together with the foreign exchange market simultaneously determines interest rate in the international loan market and the exchange rate. We also derive the conditions for existence of meaningful equilibrium solutions. Because of non-linearity of the functions we adopt a numerical solution method. A number of comparative dynamic analyses explore the impact of parameters of the model on the endogenous variables. The model is then used to explain the possibility of financial crisis originating either in the developed country or in the developing country. The explanation of crisis in this structure is based on trade theoretic terms in a dynamic terms of trade framework rather than in terms of informational imperfections.
Keywords: Capital Inflow, Interest Rate Determination, Dynamic Programming Principle, Portfolio Theory, Contagion, Financial Crisis, E-M Algorithm, Dynamic Terms of Trade
JEL Classification: C61, E44, E47, F32, F34, F42, G11
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