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Markov Switching Garch Models of Currency Crises in Southeast Asia

  • 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)

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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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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  16. Reinhart, Carmen & Goldstein, Morris & Kaminsky, Graciela, 2000. "Assessing financial vulnerability, an early warning system for emerging markets: Introduction," MPRA Paper 13629, University Library of Munich, Germany.
  17. Parkinson, Michael, 1980. "The Extreme Value Method for Estimating the Variance of the Rate of Return," The Journal of Business, University of Chicago Press, vol. 53(1), pages 61-65, January.
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  19. Chou, Ray Yeutien, 2005. "Forecasting Financial Volatilities with Extreme Values: The Conditional Autoregressive Range (CARR) Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 561-82, June.
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  24. Nelson, Daniel B & Cao, Charles Q, 1992. "Inequality Constraints in the Univariate GARCH Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(2), pages 229-35, April.
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