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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.

Suggested Citation

  • Gus Garita & Chen Zhou, 2009. "Can Open Capital Markets Help Avoid Currency Crises?," DNB Working Papers 205, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:dnbwpp:205
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    File URL: https://www.dnb.nl/binaries/Working%20paper%20205_tcm46-212965.pdf
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    References listed on IDEAS

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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. 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.
    3. van Oordt, Maarten R.C. & Zhou, Chen, 2012. "The simple econometrics of tail dependence," Economics Letters, Elsevier, vol. 116(3), pages 371-373.
    4. Garita, Gus, 2009. "How Does Financial Openness Affect Economic Growth and its Components?," MPRA Paper 20099, University Library of Munich, Germany.
    5. Garita, Gus, 2011. "The reciprocal relationship between systemic risk and real economic activity," MPRA Paper 33135, University Library of Munich, Germany.
    6. Garita, Gus, 2010. "An Inquiry into Banking Portfolios and Financial Stability Surrounding "The Great Recession"," MPRA Paper 25996, University Library of Munich, Germany.

    More about this item

    Keywords

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

    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

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