The Causes of Currency Crises: Do Fundamentals Really Matter?
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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 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.
Abstract
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 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.