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Causality between banking and currency fragilities: A dynamic panel model

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  • Shen, Chung-Hua
  • Chen, Chien-Fu
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    Abstract

    A panel dynamic model both with and without a threshold is specified to reexamine the lead-lag relationship between banking and currency fragilities. We employ banking sector fragility (BSF) and exchange market pressure (EMP) as the proxies for banking and currency fragilities, respectively, where BSF is made up of real deposits, banks' real claims on the domestic private sector and the real foreign liabilities of banks, and EMP uses the weighted average of the exchange rate changes and foreign reserves. Among the banking sector fragilities, we consider three different proxies, namely, BSF1, BSF2 and BSF3, depending on the components used. Our 51 sample countries include 21 industrial and 30 developing countries. When the whole panel dynamic model is used, bilateral causality is found between the two fragilities using all sample countries. When using only industrial country data, the bilateral causation is found only between EMP and BSF2, but no relationship is found between BSF3 and EMP, or between BSF2* and EMP. When developing countries are employed, stronger bilateral causality is found between banking and currency fragilities. When the panel threshold dynamic model is used, the results overwhelmingly suggest that bilateral causality exists.

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    Bibliographic Info

    Article provided by Elsevier in its journal Global Finance Journal.

    Volume (Year): 19 (2008)
    Issue (Month): 2 ()
    Pages: 85-101

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    Handle: RePEc:eee:glofin:v:19:y:2008:i:2:p:85-101

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    Web page: http://www.elsevier.com/locate/inca/620162

    Related research

    Keywords: Twin fragility Banking fragility Currency fragility Banking Financial Index Exchange market pressure Panel Granger causality;

    References

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    1. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," Working Paper 97-16, Federal Reserve Bank of Atlanta.
    2. Velasco, Andres, 1987. "Financial crises and balance of payments crises : A simple model of the southern cone experience," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 263-283, October.
    3. Ilan Goldfajn & Rodrigo O. Valdés, 1997. "Capital Flows and the Twin Crises : The Role of Liquidity," IMF Working Papers 97/87, International Monetary Fund.
    4. Miller, Victoria, 1996. "Speculative currency attacks with endogenously induced commercial bank crises," Journal of International Money and Finance, Elsevier, vol. 15(3), pages 383-403, June.
    5. Steven B. Kamin & Oliver D. Babson, 1999. "The contributions of domestic and external factors to Latin American devaluation crises: an early warning systems approach," International Finance Discussion Papers 645, Board of Governors of the Federal Reserve System (U.S.).
    6. Beck, T.H.L. & Levine, R. & Loayza, N., 2000. "Financial intermediation and growth: Causality and causes," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3125519, Tilburg University.
    7. Jeffrey A. Frankel & Andrew K. Rose, 1996. "Currency crashes in emerging markets: an empirical treatment," International Finance Discussion Papers 534, Board of Governors of the Federal Reserve System (U.S.).
    8. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
    9. Michael M. Hutchison & Ilan Neuberger, . "How Bad Are Twins? Output Costs of Currency and Banking Crises," EPRU Working Paper Series 02-09, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
    10. G.G. Kaufman, 2000. "Banking and Currency Crises and Systemic Risk: A Taxonomy and Review," DNB Staff Reports (discontinued) 48, Netherlands Central Bank.
    11. Enrica Detragiache & Asli Demirgüç-Kunt, 1998. "Financial Liberalization and Financial Fragility," IMF Working Papers 98/83, International Monetary Fund.
    12. Bruce E. Hansen, 1997. "Threshold effects in non-dynamic panels: Estimation, testing and inference," Boston College Working Papers in Economics 365, Boston College Department of Economics.
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    Cited by:
    1. Cevik, Emrah Ismail & Dibooglu, Sel & Kutan, Ali M., 2013. "Measuring financial stress in transition economies," Journal of Financial Stability, Elsevier, vol. 9(4), pages 597-611.

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