Cristiana Mammana and Elisabetta Michetti

Copyright © 2008 Cristiana Mammana and Elisabetta Michetti. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Abstract

This work provides a framework to analyze the role of financial development as a source of endogenous instability in emerging economies subject to moral hazard problems. We propose and study a dynamic model describing a small open economy with a tradeable good produced by internationally mobile capital and a country specific input, using Leontief technology. We demonstrate that emerging markets could be endogenously unstable since large capital inflows increase risk and exacerbate asymmetric information problems, according to empirical evidences. Using bifurcation and stability analysis, we describe the properties of the system attractors, we assess the plausibility for complex dynamics and, we find out that border collision bifurcations can emerge due to the fact that the state space is piecewise smooth. As a consequence, when a fixed or periodic point loses its stability, the final dynamics may become suddenly chaotic. This fact may explain how financial crises occurred in emerging economies.