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Selective Swap Arrangements and the Global Financial Crisis: Analysis and Interpretation

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  • Aizenman, Joshua
  • Pasricha, Gurnain

Abstract

The onset of the US credit crisis in 2008, and its rapid globalization induced the FED to extend unprecedented swap-lines of 30 billion dollars to four emerging markets, and the proliferation of other cross-countries selective swap arrangements. This paper explores the logic for these arrangements, focusing on the degree to which financial and trade linkages, financial openness and credit risk history account for discerning the formation of swap arrangements to EMs. We also study the impact of the formation of these credit lines on the exchange rate and the financial spreads of the relevant countries. We find that exposure of US banks to EMs is the most important selection criterion for explaining the “selected four†swap-lines. This result is consistent with the outlined model, where we show that in circumstances of unanticipated deleveraging, emergency swap-lines may prevent or mitigate costly liquidation today, allowing investment projects to reach maturity and providing positive option value to both the source and the recipient countries. The FED swap-lines had relatively large short-run impact on the exchange rates of the selected EMs, but much smaller effect on the spreads (measured relative to that of other EMs that were not the recipients of swap-lines). Specifically, non-swap countries saw an average depreciation of 0.15% on the day after swap announcement, but swap countries saw their exchange rate appreciate on average, by about 4%. Yet, all the swap countries saw their exchange rate subsequently depreciate to a level lower than pre-swap rate, calling into question the long-run impact of the arrangements.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt2vw7s14s.

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Date of creation: 01 Mar 2009
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Handle: RePEc:cdl:ucscec:qt2vw7s14s

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Keywords: swap-lines; deleveraging; trade and financial exposure;

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  1. Aizenman, Joshua & LEE, JAEWOO, 2005. "International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence," Santa Cruz Center for International Economics, Working Paper Series qt44g3n2j8, Center for International Economics, UC Santa Cruz.
  2. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
  3. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison," NBER Working Papers 13761, National Bureau of Economic Research, Inc.
  4. Bryant, John, 1980. "A model of reserves, bank runs, and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 4(4), pages 335-344, December.
  5. Sebastian Edwards, 2005. "Capital Controls, Sudden Stops and Current Account Reversals," NBER Working Papers 11170, National Bureau of Economic Research, Inc.
  6. Nyblom, Jukka & Harvey, Andrew, 2000. "Tests Of Common Stochastic Trends," Econometric Theory, Cambridge University Press, vol. 16(02), pages 176-199, April.
  7. Kaddour Hadri, 1999. "Testing For Stationarity In Heterogeneous Panel Data," Research Papers 1999_04, University of Liverpool Management School.
  8. Taylor, Mark P. & Sarno, Lucio, 1998. "The behavior of real exchange rates during the post-Bretton Woods period," Journal of International Economics, Elsevier, vol. 46(2), pages 281-312, December.
  9. Al-Awad, Mouawiya & Grennes, Thomas J., 2002. "Real interest parity and transaction costs for the group of 10 countries," International Review of Economics & Finance, Elsevier, vol. 11(4), pages 363-372.
  10. Edwards, Sebastian, 2007. "Capital controls, capital flow contractions, and macroeconomic vulnerability," Journal of International Money and Finance, Elsevier, vol. 26(5), pages 814-840, September.
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