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The contribution of domestic and external factors to emerging market currency crises: an early warning systems approach

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Author Info

  • Steven B. Kamin

    (International Finance Division of the Federal Reserve Board, USA)

  • John Schindler

    (International Finance Division of the Federal Reserve Board, USA)

  • Shawna Samuel

    (International Finance Division of the Federal Reserve Board, USA)

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    Abstract

    In this paper, a modified 'early warning system' (EWS) approach is developed to identify the roles of domestic and external factors in emerging market crises. Several probit models of currency crises were estimated for 26 emerging market countries. These models were used to identify the separate contributions to the probabilities of crisis of domestic and external variables. We found that, relative to domestic factors, adverse external shocks and large external imbalances contributed little to the average estimated probability of crisis in emerging market countries, but accounted for much more of the spikes in the probability of crisis estimated to occur during actual crisis years. We interpret these results to suggest that while, on average over time, domestic factors have tended to contribute to much of the underlying vulnerability of emerging market countries, adverse swings in external factors may have been important in pushing economies 'over the edge' and into currency crisis. In consequence, the costs of giving up exchange rate flexibility through adoption of strongly fixed exchange rate regimes-e.g. currency boards or dollarization-may be quite high for some countries. Published in 2007 by John Wiley & Sons, Ltd.

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    File URL: http://hdl.handle.net/10.1002/ijfe.314
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    Bibliographic Info

    Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

    Volume (Year): 12 (2007)
    Issue (Month): 3 ()
    Pages: 317-336

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    Handle: RePEc:ijf:ijfiec:v:12:y:2007:i:3:p:317-336

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    Web page: http://www.interscience.wiley.com/jpages/1076-9307/

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    Web: http://jws-edcv.wiley.com/jcatalog/JournalsCatalogOrder/JournalOrder?PRINT_ISSN=1076-9307

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    1. Fratzscher, Marcel & Matthieu Bussiere, 2003. "Towards A New Early Warning System of Financial Crises," Royal Economic Society Annual Conference 2003 81, Royal Economic Society.
    2. Rogers, John H. & Wang, Ping, 1995. "Output, inflation, and stabilization in a small open economy: Evidence from Mexico," Journal of Development Economics, Elsevier, vol. 46(2), pages 271-293, April.
    3. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
    4. Ahmed, Shaghil, 2003. "Sources of economic fluctuations in Latin America and implications for choice of exchange rate regimes," Journal of Development Economics, Elsevier, vol. 72(1), pages 181-202, October.
    5. Graciela Kaminsky & Saul Lizondo & Carmen M. Reinhart, 1998. "Leading Indicators of Currency Crises," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 1-48, March.
    6. Joseph Joyce & Linda Kamas, 1997. "The relative importance of foreign and domestic shocks to output and prices in Mexico and Colombia," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 133(3), pages 458-478, September.
    7. Hali J. Edison, 2000. "Do indicators of financial crises work? an evaluation of an early warning system," International Finance Discussion Papers 675, Board of Governors of the Federal Reserve System (U.S.).
    8. Galindo, Arturo J. & Maloney, William F., 2002. "Second moments in speculative attack models: panel evidence," Journal of International Economics, Elsevier, vol. 56(1), pages 97-129, January.
    9. Chinn, Menzie D. & Dooley, Michael P. & Shrestha, Sona, 1999. "Latin America and East Asia in the context of an insurance model of currency crises," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 659-681, August.
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    Cited by:
    1. Sugawara, Naotaka & Zalduendo, Juan, 2013. "Credit-less recoveries : neither a rare nor an insurmountable challenge," Policy Research Working Paper Series 6459, The World Bank.

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