Bubbles and Capital Flow Volatility: Causes and Risk Management, Issue 11618
National Bureau of Economic Research, 2005 - Capital market - 27 pages
"Emerging market economies are fertile ground for the development of real estate and other financial bubbles. Despite these economies' significant growth potential, their corporate and government sectors do not generate the financial instruments to provide residents with adequate stores of value. Capital often flows out of these economies seeking these stores of value in the developed world. Bubbles are beneficial because they provide domestic stores of value and thereby reduce capital outflows while increasing investment. But they come at a cost, as they expose the country to bubble-crashes and capital flow reversals. We show that domestic financial underdevelopment not only facilitates the emergence of bubbles, but also leads agents to undervalue the aggregate risk embodied in financial bubbles. In this context, even rational bubbles can be welfare reducing. We study a set of aggregate risk management policies to alleviate the bubble-risk. We show that liquidity requirements, sterilization of capital inflows and structural policies aimed at developing public debt markets "collateralized" by future revenues, all have a high payoff in this environment"--National Bureau of Economic Research web site.
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aggregate risk management Arvind Krishnamurthy avoids the credit bankers and entrepreneurs banking sector bond bubble asset bubble crashes Caballero capital market capital outflows central bank choose collateral constraint collateralized debt context crash-state credibility credit crunch crises decision problem denote developed domestic agents domestic financial dynamic inefficiency problem Effects EM's emerging markets entrepreneurial investment entrepreneurial sector financial market financial underdevelopment fragility future taxes government debt growth hard copy higher return implement inside the back interest rate international bank account international endowment international goods abroad international liquidity investing entrepreneurs investment opportunity investment projects investors large crash limited liquidity requirements Macroeconomics market clearing condition Michael Grossman NBER Working Papers Number OLG model order condition output p(+i papers in hard Partial Subscription portfolio share private sector pt+i public debt rational bubbles real estate bubble single area solve sterilization store of value sufficiently large Trade value instruments Volatility welfare maximizing