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An Article Review

An Article Review. Puan Aimy bt Md Yusof Wednesday 22/3/06. Currency Crashes In Emerging Markets by Frankel & Rose. Abstract: Panel data >100 developing countries 1971-1992 Currency crash = large ∆nominal exchrate

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An Article Review

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  1. An Article Review Puan Aimy bt Md Yusof Wednesday 22/3/06

  2. Currency Crashes In Emerging Marketsby Frankel & Rose Abstract: • Panel data • >100 developing countries 1971-1992 • Currency crash = large ∆nominal exchrate • Variables: composition/level of debt + other macroeconomic, external & foreign factors • Results: significant factors esp. GDP growth, % ∆ domestic credit, foreign i • Low FDI/debt ratio, high likelihood of crash

  3. Section 1: Intro • Main Q: Are currency crashes all alike? • Main objective: provide statistical characterization of currency crashes • Variables: 1. foreign i.e. Northern i, GDP 2. domestic i.e. GDP, monetary & fiscal shocks 3. external i.e. over-valuation, current account, level of indebtedness 4. composition of debts • Method: non-structural, univariate graphical + multivariate statistical analysis • Organization: Section 2 Definition of currency crash Section 3 Variables Section 4 Analysis Section 5 Conclusion

  4. Section 2: Definitions Q1. Limitations to definitions of currency crashes? Q2. How big of ∆exchrate is needed? Ans: Depreciation of nominal exchrate by ≥25% 10% increase in nominal rate of depreciation Q3. How to measure exchrate? Ans: % ∆ ln exchrate Q4. What about high inflation countries? Ans: changes must exceed 10% compared to previous year’s

  5. Section 3: Variables • Macroeconomic Indicators (domestic) (i) rate of growth of domestic credit, (ii) govt budget/GDP ratio, (iii) reserves/imports ratio, (iv) current acc/GDP ratio, (v) real GDP growth rate, (vi) % over-valuation • External Variables (i) debt/GNP ratio, (ii) foreign exch reserves/imports, (iii) current acc/GDP ratio, (iv) real exchrate • Debt Composition (i) FDI vs portfolio flows, (ii) long-term vs short-term portfolio capital, (iii) fixed rate vs floating rate borrowing, (iv) domestic currency vs foreign currency denomination • Foreign Variables (i) short-term Northern i, (ii) OECD real GDP growth rate

  6. Section 3: Variables Data Set: • Sources: 1994 World Bank’s World Data CD-Rom, IMF’s International Financial Statistics CD-Rom, OECD Publications • 1971-1992 annual, 105 countries

  7. Section 4: Results Event Study Methodology • Methodology: Eichengreen, Rose and Wyplosz (1995 • Found 117 crashes (-74 due to “windowing” • Mostly early-mid 1980s • Used probit models to support

  8. Section 4: Results • Graphical Analysis: • high debt burden • disproportionately small inflows of FDI • high foreign interest rates • lower Northern growth • over-valued exchange rates • low international reserves • small deficit of current account • high domestic credit growth

  9. Section 4: Results Regression Analysis: • FDI significantly associated with crash incident: a 1 % fall in FDI inflows is associated with a .3 % increase in the probability of crash • higher debt, lower reserves and a more over-valued real exchange rate raise the odds of crash incidence • high domestic credit growth and a recession both coincide with an increased probability of a crash • increases in Northern interest rates increases the likelihood of a crash • the joint effects of debt composition, external and internal effects are all significant • low fractions of debt by FDI and a high fraction by the public sector raises the probability of a crash

  10. Section 4: Results Sensitivity Analysis • low FDI flows, high domestic credit growth, low output growth and high foreign interest rates are associated with currency crashes • the interactive effects between interest rate with the debt/GDP ratio is statistically significant • countries with a lot of debt in yen did better than others

  11. Section 5: Conclusion • Definition: large currency depreciation • Annual data >100 countries >20 years • Conclude: Crashes tend to occur when there are … • Low FDI inflow • Low reserves • High domestic credit growth • High Northern i • Over-valuation of real exchrate • Sharp recessions Crashes are not predictable based on … • current account deficits • govt budget deficits

  12. Thank You !

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