Derivatives and global capital flows: applications to Asia

Abstract

The role of derivatives contracts in explaining the existence of a number of puzzles associated with the Asian financial crisis is investigated. The shift to short-term commercial bank lending in a region that traditionally relied on direct investment, the allocation of resources to low return uses in an area considered to be highly profitable, lax prudential supervision in systems that had introduced financial reforms early, and the co-movement of asset prices and exchange rates, which was to have been eliminated by direct equity investments, are all linked to the characteristics of derivative contracts used to provide lending to Asia.

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