A Model of Self-Fulfilling Financial Crises

14 Pages Posted: 8 May 2006

Abstract

This paper combines the structural weakness and the self-fulfilling panic view to explain the cause of the East Asian crises. In this model economy, the diversification strategies induce conglomerate firms to overinvest. They accumulate losses due to their unprofitable sectors and then compensate by obtaining bank loans. Domestic banks, which borrow from foreign banks, lend money as long as the total amount of accumulated loans remains within the firms' collateral value. The model shows that if the debt to collateral value ratio belongs to a certain range a self-fulfilling crisis can occur due to the self-fulfilling expectations of foreign investors.

Suggested Citation

Kim, Yong Jin and Lee, Jong-Wha, A Model of Self-Fulfilling Financial Crises. Japanese Economic Review, Vol. 57, No. 1, pp. 87-100, March 2006. Available at SSRN: https://ssrn.com/abstract=886606 or http://dx.doi.org/10.1111/j.1468-5876.2006.00313.x

Yong Jin Kim (Contact Author)

Ajou University ( email )

Woncheon-dong, Yeongtong-gu
Suwon-si, Gyeonggi-do
Korea, Republic of (South Korea)

Jong-Wha Lee

Korea University ( email )

Anam-dong, Sungbuk-Ku
Dept. of Economics
Seoul, 136-701
82-2-3290-2216 (Phone)
82-2-928-4948 (Fax)

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