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Markov Switching Garch Models of Currency Crises in Southeast Asia

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Author Info

  • Celso Brunetti

    ()
    (Department of Economics, University of Pennsylvania)

  • Roberto S. Mariano

    ()
    (Department of Economics, University of Pennsylvania and School of Economics and Social Studies, Singapore Management University)

  • Chiara Scotti

    ()
    (Department of Economics, University of Pennsylvania)

  • Augustine H. H. Tan

    ()
    (School of Economics and Social Studies, Singapore Management University)

Abstract

This paper develops a model which is able to forecast exchange rate turmoil. Our starting point relies on the empirical evidence that exchange rate volatility is not constant. In fact, the modeling strategy adopted refers to the vast literature of the GARCH class of models, where the variance process is explicitly modeled. Further empirical evidence shows that it is possible to distinguish between two different regimes: “ordinary” versus “turbulence”. Low exchange rate changes are associated with low volatility (ordinary regime) and high exchange rate devaluations go together with high volatility. This calls for a regime switching approach. In our model we also allow the transition probabilities to vary over time as functions of economic and financial indicators. We find that real effective exchange rate, money supply relative to reserves, stock index returns and bank stock index returns and volatility are the major indicators.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 03-008.

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Length: 44 pages
Date of creation: 18 Mar 2003
Date of revision:
Handle: RePEc:pen:papers:03-008

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Keywords: Currency crises; Markov Switching Models; Volatility;

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References

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  1. Kumar, Mohan & Moorthy, Uma & Perraudin, William, 2003. "Predicting emerging market currency crashes," Journal of Empirical Finance, Elsevier, Elsevier, vol. 10(4), pages 427-454, September.
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  3. Baillie, Richard T & Bollerslev, Tim, 1989. "The Message in Daily Exchange Rates: A Conditional-Variance Tale," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 7(3), pages 297-305, July.
  4. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, American Economic Association, vol. 89(3), pages 473-500, June.
  5. Barry Eichengreen, Andrew K. Rose, and Charles Wyplosz., 1995. "Speculative Attacks on Pegged Exchange Rates: An Empirical Exploration with Special Reference to the European Monetary System," Center for International and Development Economics Research (CIDER) Working Papers, University of California at Berkeley C95-046, University of California at Berkeley.
  6. Hamilton, James D. & Susmel, Raul, 1994. "Autoregressive conditional heteroskedasticity and changes in regime," Journal of Econometrics, Elsevier, Elsevier, vol. 64(1-2), pages 307-333.
  7. Reinhart, Carmen & Kaminsky, Graciela & Lizondo, Saul, 1998. "Leading Indicators of Currency Crises," MPRA Paper 6981, University Library of Munich, Germany.
  8. Hali J. Edison, 2000. "Do indicators of financial crises work? an evaluation of an early warning system," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 675, Board of Governors of the Federal Reserve System (U.S.).
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  13. Ding, Zhuanxin & Granger, Clive W. J. & Engle, Robert F., 1993. "A long memory property of stock market returns and a new model," Journal of Empirical Finance, Elsevier, Elsevier, vol. 1(1), pages 83-106, June.
  14. Catherine A. Pattillo & Andrew Berg, 1998. "Are Currency Crises Predictable? a Test," IMF Working Papers, International Monetary Fund 98/154, International Monetary Fund.
  15. Berg, Andrew & Pattillo, Catherine, 1999. "Predicting currency crises:: The indicators approach and an alternative," Journal of International Money and Finance, Elsevier, Elsevier, vol. 18(4), pages 561-586, August.
  16. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, Elsevier, vol. 41(3-4), pages 351-366, November.
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  19. Nelson, Daniel B & Cao, Charles Q, 1992. "Inequality Constraints in the Univariate GARCH Model," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 10(2), pages 229-35, April.
  20. Graciela Laura Kaminsky, 1999. "Currency and Banking Crises," IMF Working Papers, International Monetary Fund 99/178, International Monetary Fund.
  21. Bera, Anil K & Higgins, Matthew L, 1993. " ARCH Models: Properties, Estimation and Testing," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 7(4), pages 305-66, December.
  22. Parkinson, Michael, 1980. "The Extreme Value Method for Estimating the Variance of the Rate of Return," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 53(1), pages 61-65, January.
  23. Gray, Stephen F., 1996. "Modeling the conditional distribution of interest rates as a regime-switching process," Journal of Financial Economics, Elsevier, Elsevier, vol. 42(1), pages 27-62, September.
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Citations

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Cited by:
  1. Giampiero M. Gallo & Edoardo Otranto, 2007. "Volatility transmission across markets: a Multichain Markov Switching model," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 17(8), pages 659-670.
  2. Khalifa, Ahmed A.A. & Hammoudeh, Shawkat & Otranto, Edoardo, 2014. "Patterns of volatility transmissions within regime switching across GCC and global markets," International Review of Economics & Finance, Elsevier, Elsevier, vol. 29(C), pages 512-524.
  3. Humala, Alberto & Rodríguez, Gabriel, 2009. "Foreign Exchange Intervention and Exchange Rate Volatility in Peru," Working Papers, Banco Central de Reserva del Perú 2009-008, Banco Central de Reserva del Perú.
  4. Kim Liow & Zhiwei Chen & Jingran Liu, 2011. "Multiple Regimes and Volatility Transmission in Securitized Real Estate Markets," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 42(3), pages 295-328, April.
  5. Giampiero Gallo & Edoardo Otranto, 2007. "Volatility Spillovers, Interdependence and Comovements: A Markov Switching Approach," Econometrics Working Papers Archive, Universita' degli Studi di Firenze, Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti" wp2007_11, Universita' degli Studi di Firenze, Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti".

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