The Causes of Currency Crises: Do Fundamentals Really Matter?

This paper aims to find deterministic factors of recent crisis in East Asia and Latin America by conducting empirical tests for each crisis-hit country instead of analyzing the panel data. In particular, the focus of the study lies in verifying whether economic fundamentals matter as a common factor of crisis and whether the contagion is significant. Through probit estimations and Granger-causality test, strong evidence is found that accumulation of current account deficits and excessThis paper aims to find deterministic factors of recent crisis in East Asia and Latin America by conducting empirical tests for each crisis-hit country instead of analyzing the panel data. In particular, the focus of the study lies in verifying whether economic fundamentals matter as a common factor of crisis and whether the contagion is significant. Through probit estimations and Granger-causality test, strong evidence is found that accumulation of current account deficits and excessive increase in foreign borrowings and lending booms are highly correlated to the outbreak of a crisis in many countries. However, the contagion effect was emphatic in South Korea, Indonesia and Malaysia; currency crisis in these countries can be attributable not only to the deterioration of their fundamentals but largely to the foreign investors' excessively over-reactive panic and herd behavior.