Margin Calls, Trading Costs, and Asset Prices in Emerging Markets: The Finanical Mechanics of the 'Sudden Stop' Phenomenon / Enrique G. Mendoza, Katherine A. Smith.

Format:

Book

Author/Creator:

Mendoza, Enrique G.

Contributor:

National Bureau of Economic Research.

Smith, Katherine A.

Series:

Working Paper Series (National Bureau of Economic Research) no. w9286.

NBER working paper series no. w9286

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Margin Calls, Trading Costs, and Asset Prices in Emerging Markets

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2002.

Summary:

A central feature of emerging markets crises is the Sudden Stop' phenomenon characterized by large reversals of capital inflows and current accounts, deep recessions, and collapses in asset prices. This paper proposes an open-economy asset-pricing model with financial frictions that yields predictions in line with these observations. Margin requirements and information costs distort asset trading between a small open economy and foreign securities firms. If the economy's debt-equity ratio is low, standard productivity shocks cause normal recessions with smooth current-account adjustments. If the ratio is high, the same productivity shocks trigger margin calls forcing domestic agents to firesell equity to foreign traders who are slow to adjust their portfolios. This sets off a Fisherian asset-price deflation and subsequent rounds of margin calls. A current account reversal and a collapse in consumption occur if the fire-sale of assets cannot prevent a sharp increase in net foreign asset holdings.

Notes:

Print version record

October 2002.