TY  - JOUR
AU  - Mendoza,Enrique G.
AU  - Smith,Katherine A.
TI  - Margin Calls, Trading Costs, and Asset Prices in Emerging Markets: The Finanical Mechanics of the 'Sudden Stop' Phenomenon
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 9286
PY  - 2002
Y2  - October 2002
UR  - http://www.nber.org/papers/w9286
L1  - http://www.nber.org/papers/w9286.pdf
N1  - Author contact info:
Enrique G. Mendoza
Department of Economics
University of Maryland
College Park, MD 20742
Tel: 301/405-3845
Fax: 301/405-7835
E-Mail: mendozae@econ.umd.edu

Katherine Smith
United States Naval Academy
Department of Economics
589 McNair Road
Mail Stop 10-D
Annapolis, MD 21402
Tel: 410/293-6882
Fax: 410/293-6899
E-Mail: ksmith@usna.edu
AB  - A central feature of emerging markets crises is the  Sudden Stop' phenomenon characterized by large reversals of capital inflows and current accounts, deep recessions, and collapses in asset prices. This paper proposes an open-economy asset-pricing model with financial frictions that yields predictions in line with these observations. Margin requirements and information costs distort asset trading between a small open economy and foreign securities firms.  If the economy's debt-equity ratio is low, standard productivity shocks cause normal recessions with smooth current-account adjustments. If the ratio is high, the same productivity shocks trigger margin calls forcing domestic agents to firesell equity to foreign traders who are slow to adjust their portfolios. This sets off a Fisherian asset-price deflation and subsequent rounds of margin calls. A current account reversal and a collapse in consumption occur if the fire-sale of assets cannot prevent a sharp increase in net foreign asset holdings.
ER  -