Capital Flows and Asset Prices

After liberalizing international transactions of financial assets, many countries experiencelarge swings in asset prices, capital flows, and aggregate production. This paper studies howthe adjustment to capital account liberalization depends upon the degree of development of adomestic financial system, and why the economy with an underdeveloped financial systemmay be vulnerable to shocks to the domestic and foreign finance. We construct a model of asmall open economy in which it is difficult to enforce debtors to repay their debts unless thedebts are secured by collateral, and assets usable as collateral for international borrowing aremore restricted than domestic borrowing.[...]