How Much Does Trade and Financial Contagion Contribute to Currency Crises? The Case of Korea
AbstractThe prime task of modelling cross-market contagion is to predict the imminence of a pestilent currency crisis. Empirical models are developed here to study the roles and channels of contagion in exchange rate volatilities, in ways which are as economically sound and econometrically simple as possible. Korea is used as the susceptible and eight adjacent economies as the potential infective. Two channels of contagion are investigated -- trade linkage and financial market linkage. Two key features of the latter channel are carefully specified -- the changing degrees of infectiveness of a neighbouring economy due to its changing capital mobility, and the changing intensity of currency speculation in response to the changing vulnerability of the susceptible. By using monthly data prior to the 1997 Korean won crisis, the models predict a looming currency collapse. Since the respective roles of major internal and external factors which propagate shocks to the won rate are carefully identified in the models, it is thus manifest that contagion indeed played a major role in the won collapse, that financial contagion was the main culprit whereas trade contagion played only a minor part, and that the susceptible is especially prone to shocks from economies which are structurally similar to or weaker than it.
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Bibliographic InfoPaper provided by Queen Mary, University of London, School of Economics and Finance in its series Working Papers with number 410.
Date of creation: Mar 2000
Date of revision:
Currency crisis; Trade contagion; Financial contagion; Infective; Susceptible; Capital mobility; International financial market; Herding; Heterogeneous trading; Currency speculation; Discrete-state regression;
Find related papers by JEL classification:
- D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
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- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
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- O23 - Economic Development, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
This paper has been announced in the following NEP Reports:
- NEP-ALL-2000-03-27 (All new papers)
- NEP-FMK-2000-03-27 (Financial Markets)
- NEP-IFN-2000-03-27 (International Finance)
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