| Abstract: | Emerging market financial crises are abrupt and dramatic usually occurring after a precrisis bonanza. This paper develops an equilibrium asset pricing model with informational frictions in which crisis itself is a consequence of the investor optimism in the period preceding the crisis. If preceded by a sequence of positive signals, a small, negative noise shock can trigger a downward adjustment in investors' beliefs, asset prices, and consumption. The magnitude of this downward adjustment increases with the level of optimism attained prior to the negative signal. Moreover, with informational frictions, asset prices display persistent effects in response to transitory shocks. |
