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Earlier versions of this paper were presented to the Allied Social Sciences Association annual meeting in New York, January 3-5, 1999, and to a conference on “Financial Crises in Emerging Markets” at the Federal Reserve Bank of San Francisco, September 23-24, 1999. I am grateful to Olivier Jeanne and Marcus Miller for useful discussions of the issues treated here, and to Joshua Aizenman, Roberto Chang, Enrica Detragiache, Ilan Goldfajn, Caroline Van Rijckeghem, and Tony Richards for helpful comments. Freyan Panthaki and Haiyan Shi provided research assistance, and Subramanian Sriram helped in gathering the data.
For a discussion of this episode and the resulting loss of confidence in the Mexican authorities, see Agénor and Masson (1999).
Strictly speaking, these models yield a unique set of expectations, but they are sensitive to initial conditions. Thus, this class of models can be seen as providing explanations for the seemingly arbitrary formation of expectations. These expectations in turn may be consistent with one or another of the macroeconomic equilibria described under II. A or II. B above, and hence be self-fulfilling.
In a forthcoming paper, Arifovic and Masson (1999), we consider boundedly rational agents who imitate others as well as experimenting in forming their expectations. Simulations replicate boom and bust cycles in lending to emerging market countries, and associated currency crises.
Corsetti, Pesenti and Roubini (1998) and Irwin and Vines (1999) offer models that similarly stress the role of government incentives and guarantees in leading to unprofitable investment. See Marion (1999) for an interesting discussion of the Dooley model.
Discounted dividends, not contemporaneous dividends, should explain equity prices but lack of observations precluded doing this calculation. In any case, at an annual frequency dividends are already fairly smooth. See Shiller (1989), chapter 10, who finds excess co-movement between United States and United Kingdom stock price indexes.
All indices are in local currency, so the co-movement of exchange rates (relative for instance to the dollar) in emerging market crises are not the source of the excess correlation of stock prices.
This is a modified version of a table I used to focus discussion of a paper by Holger Wolf (1999), at a conference at the World Bank on Capital Flows, Financial Crisis and Policies, April 15-16, 1999. Rather than providing another survey of the relevant theories, the interested reader is referred to Wolf (1999).
For instance, the Investment Company Institute (1998) estimated that at the end of 1996, U.S. open-end emerging market equity mutual funds that invested primarily in Asia constituted only 0.8 percent of the value of these stock markets.