A Theoretical Model of Financial Crisis

11 Pages Posted: 25 Apr 2002

See all articles by Jorge A. Chan-Lau

Jorge A. Chan-Lau

International Monetary Fund (IMF) - International Capital Markets Department

Zhaohui Chen

International Monetary Fund (IMF)

Abstract

The paper develops a new model of private debt financing with an inefficient financial system at its core, where inefficiency is characterized by costly loan monitoring. The model suggests a mechanism that generates the following series of events: a period of low capital inflow despite high rates of economic growth (capital inflow inertia), as observed in the take-off era in the Asian tiger economies; followed by a sudden acceleration of capital inflow (as seen in the 1990s); and then by a crisis, which is defined as a large reduction in the amount of loans intermediated by the financial system (i.e., a large capital outflow or credit crunch). Under certain conditions, financial crisis can occur even when economic fundamentals and market sentiment change only slightly. Unlike most credit rationing models, the results presented here do not hinge on the assumption of asymmetric information. The model also provides guidance about the appropriate policy responses to an imminent crisis.

Suggested Citation

Chan-Lau, Jorge Antonio and Chen, Zhaohui, A Theoretical Model of Financial Crisis. Available at SSRN: https://ssrn.com/abstract=309452

Jorge Antonio Chan-Lau (Contact Author)

International Monetary Fund (IMF) - International Capital Markets Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Zhaohui Chen

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-6480 (Phone)
202-623-4740 (Fax)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
24
Abstract Views
2,027
PlumX Metrics