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Can Open Capital Markets Help Avoid Currency Crises?

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  • Gus Garita
  • Chen Zhou

Abstract

By 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 “cross-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 “cross-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 Info

Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 205.

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Date of creation: Feb 2009
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Handle: RePEc:dnb:dnbwpp:205

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Related research

Keywords: Crisis; Contagion; Cross-Market Rebalancing; Exchange Market Pressure; Extreme Value Theory; Financial Integration.;

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References

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Citations

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Cited by:
  1. Garita, Gus, 2009. "Risk-Factor Portfolios and Financial Stability," MPRA Paper 19611, University Library of Munich, Germany, revised 11 Dec 2009.
  2. van Oordt, Maarten R.C. & Zhou, Chen, 2012. "The simple econometrics of tail dependence," Economics Letters, Elsevier, vol. 116(3), pages 371-373.
  3. Garita, Gus, 2010. "An Inquiry into Banking Portfolios and Financial Stability Surrounding "The Great Recession"," MPRA Paper 25996, University Library of Munich, Germany.
  4. Garita, Gus, 2009. "How Does Financial Openness Affect Economic Growth and its Components?," MPRA Paper 20099, University Library of Munich, Germany.
  5. Marco Rocco, 2011. "Extreme value theory for finance: a survey," Questioni di Economia e Finanza (Occasional Papers) 99, Bank of Italy, Economic Research and International Relations Area.
  6. Garita, Gus, 2011. "The reciprocal relationship between systemic risk and real economic activity," MPRA Paper 33135, University Library of Munich, Germany.

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