Essays on financial crises
In the past two decades, we have observed a number of financial crises both in emerging and industrial economies. A crisis is often followed by a severe economic recession, and sometimes its effects are extremely devastating. This drastic nature of financial crises has been attracting active research interests; analyzing the causes and propagation mechanism of crises and comparing possible policy options. Each chapter in this dissertation provides theoretical analyses on the mechanics and implications of financial crises. In doing so, we have paid a special attention to explaining the whole boom-bust cycle around a crisis within a model. Often, a crisis, taking the form of a collapse in asset prices, plunge in bank credit, and capital flight, is preceded by a period of boom in asset prices, bank lending, investment, and capital inflows, which ex post seem to have been excessive in their magnitude and embedded risk. Chapter 1 focuses on the role of informational inefficiency combined with government guarantee. We take the information cascade model and extend it to add the reversibility of investment as a result of higher liquidation value brought by the guarantee. The model produces initial overinvestment preventing efficient information accumulation in the market, and high likelihood of following crisis triggered by actions of later investors. Chapter 2 presents a model comparing the following two competing hypothesis. An economy with shorter term and volatile capital inflows faces to the higher crisis likelihood. On the other hand, firms might optimally use short-term debt to reduce financing costs. We show that the market solution may involve excessive use of short-term debt relative to the socially optimal allocation. Chapter 3 sheds the light on the observation that capital account liberalization often precedes a boom-bust cycle, particularly in economies with inefficient financial system in controlling agency problems. Our model shows that an economy is more likely to experience the cycle when its financial system is poor at controlling the agency problem. The agency problem results in inefficient investment. This loss can be large enough to offset the benefits of liberalization.
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