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Measuring the Degree of Currency Misalignment Using Offshore Forward Exchange Rates: The Case of the Korean Financial Crisis

Author

Listed:
  • Daekeun Park

    () (Hanyang University)

  • Changyong Rhee

    () (Seoul National University and University of Rochester)

Abstract

This paper proposes a new method of measuring the degree of currency misalignment through the use of offshore forward exchange rates. Using default risk adjusted no­arbitrage conditions for forward exchange contracts, we calculate the spot exchange rates and the domestic interest rates that are implied from the observed forward exchange rates. The difference between the implied and the observed spot exchange rates is our measure of currency misalignment. Our methodology is based on the presumption that, during a currency crisis, offshore forward exchange rates reflect market sentiments more closely than onshore spot and forward exchange rates. The latter are usually tightly regulated and heavily affected by government intervention during a non­normal event such as a financial crisis. We apply the method to the Korean financial crisis in 1997 and discuss its implication for evaluating the IMF adjustment program and explaining foreign capital flows.

Suggested Citation

  • Daekeun Park & Changyong Rhee, 2000. "Measuring the Degree of Currency Misalignment Using Offshore Forward Exchange Rates: The Case of the Korean Financial Crisis," RCER Working Papers 470, University of Rochester - Center for Economic Research (RCER).
  • Handle: RePEc:roc:rocher:470
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    File URL: http://rcer.econ.rochester.edu/RCERPAPERS/rcer_470.pdf
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    References listed on IDEAS

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    1. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
    2. Jong-Wha Lee and Changyong Rhee, 1999. "Social Impacts of the Asian Crisis: Policy Challenges and Lessons," Human Development Occasional Papers (1992-2007) HDOCPA-1999-02, Human Development Report Office (HDRO), United Nations Development Programme (UNDP).
    3. Corbo, Vittorio & Fischer, Stanley, 1995. "Structural adjustment, stabilization and policy reform: Domestic and international finance," Handbook of Development Economics,in: Hollis Chenery & T.N. Srinivasan (ed.), Handbook of Development Economics, edition 1, volume 3, chapter 44, pages 2845-2924 Elsevier.
    4. Louis Dicks-Mireaux & Miguel A Savastano & Adam Bennett & María Vicenta Carkovic S. & Mauro Mecagni & James A John & Susan M Schadler, 1995. "IMF Conditionality; Experience Under Stand-by and Extended Arrangements, Part I: Key Issues and Findings," IMF Occasional Papers 128, International Monetary Fund.
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    6. 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, vol. 89(3), pages 473-500, June.
    7. Borensztein, Eduardo & Lee, Jong-Wha, 2002. "Financial crisis and credit crunch in Korea: evidence from firm-level data," Journal of Monetary Economics, Elsevier, vol. 49(4), pages 853-875, May.
    8. Jeffrey D. Sachs, 1985. "External Debt and Macroeconomic Performance in Latin America and East Asia," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 16(2), pages 523-573.
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    11. Mohsin S. Khan, 1990. "The Macroeconomic Effects of Fund-Supported Adjustment Programs," IMF Staff Papers, Palgrave Macmillan, vol. 37(2), pages 195-231, June.
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    Cited by:

    1. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2001. "Hedging and financial fragility in fixed exchange rate regimes," European Economic Review, Elsevier, vol. 45(7), pages 1151-1193.

    More about this item

    Keywords

    currency misalignment; covered interest parity; non­deriverable forwards; Korean financial crisis;

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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