CONTAGION IN EMERGING MARKETS: when Wall Street is a carrier

The paper examines the case in which the capital market is populated by informed and uninformed investors. The uninformed try to extract information from informed investors’ trades. This opens up the possibility that if informed investors are forced to sell emerging market securities to meet margin calls, for example, this action may be misread by the uninformed investors as signaling low returns in emerging markets. The paper presents a simple model in which this type of Wall Street confusion may result in a collapse in emerging markets’ output. * A rough version of these notes was presented at the AEA 1999 New York Meetings, and at the Winter Camp in International Finance, organized by the Center for International Economics (University of Maryland) and the Faculty of Economics (Universidad de los Andes, Bogota, Colombia) in Cartagena, Colombia, January 7-11, 1999. I would like to acknowledge with thanks useful comments by Enrique Mendoza, Maury Obstfeld, and other seminar participants. 1 In Calvo (1998 a) I have argued that the analysis underlying the sustainability of current account deficits leaves much to be desired, but the topic will not be discussed because it is not central for our purposes here. 1