Globalization and Emerging Markets: With or Without Crash?

Philippe Martin and Helene Rey

No 11550, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper develops a theory of financial crisis based on the demand side of the economy. We analyze the impact of financial and trade globalizations on asset prices, investment and the possibility of self-fulfilling financial crashes. In a two-country model, we show that financial and trade globalizations have different effects on asset prices, investment and income in the emerging market and in the industrialized country. Whereas trade globalization always has a positive effect on the emerging market, financial globalization may not, especially when trade costs are high. For intermediate levels of financial transaction costs and high levels of trade costs, pessimistic expectations can be self-fulfilling and may lead to a collapse in demand for goods and assets of the emerging market. Such a crash in asset prices is accompanied by a current account reversal, a drop in income and investment and more market incompleteness. We show that countries with lower income are more prone to such demand-based financial crashes. Our model can replicate the main stylized facts of financial crashes in emerging markets. Our results strongly suggest that emerging markets should liberalize trade in goods before trade in assets.

JEL-codes: F3 F4 (search for similar items in EconPapers)
Date: 2005-08
New Economics Papers: this item is included in nep-fmk and nep-pke
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Citations: View citations in EconPapers (22)

Published as Philippe Martin & Hélène Rey, 2006. "Globalization and Emerging Markets: With or Without Crash?," American Economic Review, American Economic Association, vol. 96(5), pages 1631-1651, December.

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Related works:
Journal Article: Globalization and Emerging Markets: With or Without Crash? (2006)
Working Paper: Globalization and Emerging Markets: With or without Crash? (2006)
Working Paper: Globalization and Emerging Markets: With or Without Crash? (2006)
Working Paper: Globalization and Emerging Markets: With or without Crash? (2006)
Working Paper: Globalization and Emerging Markets: With or Without Crash? (2006)
Working Paper: Globalization and Emerging Markets: With or Without Crash? (2005)
Working Paper: Globalization and Emerging Markets: With or Without Crash? (2005)
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