Can Open Capital Markets Help Avoid Currency Crises?
AbstractBy proposing a measure for cross-market rebalancing effects, we provide new insights into the different sources of currency crises. We address three interrelated questions: (i) How can we best capture contagion; (ii) Is the contagion of currency crisis a regional or global phenomenon?; and (iii) By controlling for â€œcross-market rebalancing do other mechanisms like "financial openness" increase the probability of a currency crisis? We introduce the concept of conditional probability of joint failure (CPJF) to measure the linkages of currency crisis intra- and inter-regionally. From estimating this measure, we test for contagion and conclude that contagion only exists regionally. Furthermore, we construct a â€œcross-market rebalancing variable based on the regional CPJF. By employing a probit model to compare our new variable with a regular contagion variable often used in literature, we conclude that our new variable captures contagion better; moreover, it also captures cross-market rebalancing effects. When we properly account for these effects, then financial openness helps to diminish the probability of a currency crisis even after controlling for the onset of a banking crisis. We also show that monetary policy geared towards price stability reduces the probability of a currency crisis.
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Bibliographic InfoPaper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 205.
Date of creation: Feb 2009
Date of revision:
Crisis; Contagion; Cross-Market Rebalancing; Exchange Market Pressure; Extreme Value Theory; Financial Integration.;
Find related papers by JEL classification:
- C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- F15 - International Economics - - Trade - - - Economic Integration
- F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
- F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-03-07 (All new papers)
- NEP-IFN-2009-03-07 (International Finance)
- NEP-MAC-2009-03-07 (Macroeconomics)
- NEP-MON-2009-03-07 (Monetary Economics)
- NEP-OPM-2009-03-07 (Open Economy Macroeconomic)
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