Private Sector Risk and Financial Crises in Emerging Markets


  •  Corresponding author: Betty C. Daniel, Department of Economics, University at Albany - SUNY, Albany, NY 12222, USA. Email:

  • The author thanks the editor, Andrew Scott and a referee for helpful suggestions for revisions. Additionally, thanks go to John Jones, Enrique Mendoza and seminar participants at Claremont Graduate School, Cornell University and Williams College for helpful comments on earlier drafts. Thanks also go to the Board of Governors of the Federal Reserve where the author worked on revisions while serving in a visiting position. The views in this article are solely the responsibility of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve or of any other person associated with the Federal Reserve System.


Investment necessary for growth is risky and often requires external financing. We present a model in which capital market imperfections separate countries into a safe credit club of industrial countries, with low interest rates and steady credit access and a risky club of emerging markets, with high interest rates and volatile access. In an emerging market, a large negative productivity shock interacts with credit-market imperfections to trigger a severe contraction in external lending. Domestic agents react with widespread default. We calibrate to South Korean parameters and argue that the 1998 financial crisis could have been the downside of risky investment financed in imperfect capital markets.