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Current Issues in Finance: An Overview of the Latest Developments of the financial world

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10 III. STOCK MARKET VOLATILITY AND ECONOMIC PERFORMANCE Stock market volatility is probably the main cause of the financial crises in DCs, since it has a destabilizing effect on the overall economic environment: ™ It tends to increase the real interest rate. ™ It produces wide exchange rate fluctuations. ™ It is likely to create asset prices �bubbles�. ™ It harms the banking system. Increase in Real Interest Rate. High degree of market volatility frightens risk- adverse savers and investors: they become extremely reluctant to lending and investing. This leads to an increase in the real interest rate, and thus an increase of the cost of capital for businesses. Exchange Rate Fluctuations. High share price fluctuations lead investors to buy enormous amounts of shares when share prices are increasing, and to sell enormous amounts when share prices are decreasing. Since cash inflows in the stock market of DCs come mostly from foreign investors, a massive inflow and outflow of foreign currencies implies wide exchange rate fluctuation. Moreover, DCs have generally a high degree of debt with foreign countries and thus, when their local currency weakens, interest repayments to those foreign countries become extremely costly, sometimes unaffordable. This can lead to severe financial crises (e.g. Mexico 1994), which would generally involve long periods of economic regression. Asset Prices Bubbles. Wide share fluctuations often bring share prices at very high levels, which do not reflect their real value. Hence, the assets of the corporations that invest their resources in the stock market may be overestimated. Unquestionably, the banking industry, which is the industry with the largest percentage of assets invested in the stock market, is the most affected by share price fluctuations. Banks may therefore have inflated assets during high share price periods, . Harm to the Banking System. Conversely, market volatility also brings share price to very low levels, and when this happens bank�s assets shrink. Hence, the asset quality in the banks balance sheet deteriorates as a consequence of market volatility. This phenomenon weakens the overall banking system and brings macroeconomic instability.

Anteprima della Tesi di Massimiliano Neri

Anteprima della tesi: Current Issues in Finance: An Overview of the Latest Developments of the financial world, Pagina 10

Tesi di Master

Autore: Massimiliano Neri Contatta »

Composta da 118 pagine.

 

Questa tesi ha raggiunto 1104 click dal 20/03/2004.

 

Consultata integralmente 6 volte.

Disponibile in PDF, la consultazione è esclusivamente in formato digitale.