Political conditions and currency crises in emerging markets

This article demonstrates the impact of structural political conditions on the likelihood of currency crises in emerging markets. Controlling for a standard and parsimonious set of macroeconomic variables, I find that: right-wing government is less conducive to currency crises; ‘strong’ governments (those with larger legislative majorities and those which face more fragmented legislative opposition) are also less vulnerable. Democracy also reduced the likelihood of currency crises in emerging markets; yet, in contrast to previous studies, this article does not find a significant impact of elections on the likelihood of currency crises.     

Behavior of output during currency crises

This paper documents the behavior of output and its association with other macroeconomic variables in 195 episodes of currency crises in developing countries during 1970-2000. We find that about 60% of the crises are contractionary, while the rest are expansionary. Crises are one and a half times more likely to be contractionary in emerging markets than in other developing economies. The number of contractionary crises or their severity does not increase in the 1990s. Economies which experience capital inflows in the years prior to the crisis or an increase in external debt burden during the crisis are more likely to slow down during crises, while those with restrictions on capital flows prior to the crisis or are more open to international trade are less likely to do so. The results are robust to different ways of measuring changes in output during crises.     

Dynamics of currency crises with asset market frictions

This paper presents a dynamic model of currency crises with frictions. By construction, a speculative attack is not an instantaneous event but takes a little time to deplete the country's reserves and, in the event of an attack, agents are uncertain about whether they will be able to act before the devaluation comes. The currency will be overvalued (‘ripe for attack’) for a long time before an attack takes place. A discrete and sizable devaluation will occur. Small changes in fundamentals may trigger an attack. The model brings insights about the dynamics of currency crises and the effects of some key policy variables.     

Dealing with financial crises in emerging markets

Financial crises in emerging markets are a reality of doing business in these countries in the early twenty‐first century. Managers can gain some perspective on this problem from experiences of firms in crises that occurred in Mexico, Thailand, and Russia during the 1990s. We show how firms have taken steps to protect themselves against financial crises and to deal with the crises once underway in these three countries. Such strategies are divided into frameworks of: short‐term, immediate responses to a crisis; intermediate steps during the period of economic downturn; and long‐term continuing responses for operating in emerging markets. © 2002 Wiley Periodicals, Inc.     

Revisiting capital account convertibility in the aftermath of the currency crises

While there are a number of theoretical arguments in favour of capital account convertibility, or free cross-border capital mobility, in the real world cross-border trade in financial assets can in fact reduce welfare due to the effects of domestic distortions. The following paper examines the causes of the Asian financial crises of the late 1990s in this light and presents some of the lessons that would be instructive for a more effective implementation of capital account convertibility.     

Hard currency indebtedness of the developed socialist countries

In recent years the problems of the indebtedness of the communist countries have been driven somewhat into the background by the high foreign indebtedness of many developing countries and the attention attracted by the balance of payments crises in Brazil and Mexico. Yet there are many indications that the need for the socialist debtor nations to adjust their balance of payments policy has not lessened but, to a large extent, simply been deferred. It is therefore not unlikely that the 1980s will witness a new need to solve the problems of those nations and their creditors in the West.     

Financial liberalization and banking crises in emerging economies

Financial liberalization often leads to financial crises. This link has usually been attributed to poorly designed banking systems, an explanation that is largely static. In this paper we develop a dynamic explanation, by modelling the evolution of a newly-liberalized bank's opportunities and incentives to take on risk over time. The model reveals that even if a banking system is well-designed, in the sense of having good long-run properties, many countries will enjoy an initial period of rapid, low-risk growth and then enter a period with an elevated risk of banking crisis. This transition emerges because of the way in which the degree of foreign competition, the marginal product of capital, and the bank's own net worth simultaneously evolve.     

Business innovations from emerging market countries into developed countries: Implications for multinationals from developed countries

This article addresses innovation and emerging‐market countries. Both are important topics in the business world today. The focus of this article is on the importance of innovation and market development in emerging‐market countries by Western multinational companies typically based in North America and Western Europe. The authors of this article argue that as Western multinationals innovate and develop emerging markets, this will give multinationals the opportunity not only to compete effectively in emerging markets but also to protect their home markets in developed countries. Implications for Western multinationals are discussed. © 2012 Wiley Periodicals, Inc.     

Novelties of financial crises in the 1990s and the search for new indicators

This paper argues that, first, despite some similarities, financial crises in the 1990s have featured substantial differences between them: the ERM crisis of 1992–1993 was mainly due to stringent monetary policies; the Mexican crisis of 1994–1995 was associated to private overconsumption; and the East Asian crisis of 1997–1999 were basically the result of private overinvestment. Therefore, as crises do not seem to present strong regularities over time, the task of trying to predict them on the basis of past developments is surely doomed to fail. As crises might be simply unpredictable, specialists should refrain from creating and developing predictors and focus instead on simpler early-warning indicators. Second, the paper reviews the main body of literature on leading indicators of crises and it suggests that the bulk of these conventional indicators do not seem to be appropriate to the East Asian episodes. In order to create a new set of early-warning indicators, economists should focus on non-conventional deficiencies, such as those related to financial fragility associated with financial deregulation and with capital inflows, to a declining efficiency of investment, and to a high short-term external debt (especially as a proportion of foreign exchange reserves).     

Predicting financial crises in emerging markets using a composite non-parametric model

The large number of financial crises in emerging markets over the past ten years has left many observers, both from academia and financial institutions, puzzled by an apparent lack of homogenous causal relations between endogenous economic variables and the bursting of large financial shocks. The paper aims at showing that the key difficulty is not the identification of proper endogenous variables, but the ability to combine them in a way that is able to capture the combinatorial aspect of such causal relations. The paper is based on a newly developed non-parametric methodology for country risk signaling: the RiskMonitor CDM-Model. Using a combination of macroeconomic indicators and a composite model of 5 modern non-parametric classification methods, we constructed 9 early warning signals to predict financial crises in emerging markets. These signals are constructed for 3 types of crises (cyclical crises, exchange rate crises and transfer crises) and over 3 horizons (less than 1 year, 1 to 3 years, 3 to 5 years). This complex use of quantitative models is able to provide excellent early warning information, with impressive back-testing results on 50 developing countries over the period 1980 to 2002.     

The anatomy of financial crises: Evidence from the emerging ADR market

We study the anatomy of recent financial crises in Mexico, East Asia, Russia, Brazil, Turkey, and Argentina by investigating the efficiency and pricing of the emerging American depositary receipt (ADR) market. We use a non-parametric technique to test for persistent regime shifts in two basic structural relationships for ADR returns in 20 emerging countries — identified via arbitrage and capital mobility considerations — that should always hold in efficient and integrated capital markets. We find that those “normal” market conditions were instead often violated in proximity of financial crises: The law of one price often weakened (by 54% on average) and domestic sources of risk became more important (often by more than 100%) for many emerging ADRs. We also find the likelihood of these regime shifts to be related to proxies for uncertainty among investors, exchange rate volatility, trade linkages, and liquidity (but not stock market trends, currency devaluations, capital flight, or capital controls).     

The anatomy of financial crises: Evidence from the emerging ADR market

We study the anatomy of recent financial crises in Mexico, East Asia, Russia, Brazil, Turkey, and Argentina by investigating the efficiency and pricing of the emerging American depositary receipt (ADR) market. We use a non-parametric technique to test for persistent regime shifts in two basic structural relationships for ADR returns in 20 emerging countries — identified via arbitrage and capital mobility considerations — that should always hold in efficient and integrated capital markets. We find that those “normal” market conditions were instead often violated in proximity of financial crises: The law of one price often weakened (by 54% on average) and domestic sources of risk became more important (often by more than 100%) for many emerging ADRs. We also find the likelihood of these regime shifts to be related to proxies for uncertainty among investors, exchange rate volatility, trade linkages, and liquidity (but not stock market trends, currency devaluations, capital flight, or capital controls).     

Heterogeneity of sovereign rating migrations in emerging countries

This is a unique study of the relationship between emerging sovereign rating migrations and the sources of rating heterogeneity. It employs data from six international rating agencies and 90 emerging countries. Rating momentum is present, and we are the first to document that multiple-notch rating changes have greater impact on the probability of subsequent rating actions. Watchlist status is influential on migration probabilities, and dominates rating momentum in some cases. Rating duration, existing rating and issuer's domicile region are useful determinants in modelling the migration process. Notably, considerable inter-agency differences are revealed, suggestive of different rating processes being employed.     

Managers, investors, and crises: mutual fund strategies in emerging markets

We examine the trading strategies of mutual funds in emerging markets. We develop a method for disentangling the behavior of fund managers from that of underlying investors. For both managers and investors, we strongly reject the null hypothesis of no momentum trading: mutual funds systematically sell losers and buy winners. Selling current losers and buying current winners is stronger during crises, and equally strong for managers and investors. Selling past losers and buying past winners is stronger for managers. Managers and investors also practice contagion trading—they sell (buy) assets from one country when asset prices fall (rise) in another.     

The macroeconomic role of currency reserve accumulation in emerging markets—The Asian experience

The impact of currency reserve accumulation is controversially discussed since reserve accumulation potentially destabilises the international financial system and causes crises due to higher systemic risk. The main aim of this paper is to put the macroeconomic role of currency reserve accumulation for four Asian economies under closer scrutiny. The key question is whether accumulating currency reserves is beneficial from a long‐run perspective. Based on a vector error correction approach, we start by analysing long‐run steady‐state relationships between currency reserves, exchange rates against the US dollar, real GDP and interest rates. Our findings show that cumulated currency reserve shocks significantly affect real GDP . A likely explanation for our finding is that accumulation of reserves has supported growth through providing liquidity and supporting the development of the financial sector for the economies under observation.     

Capital flows,current account deficits,and financial crises in emerging market economies

Some emerging market economies are said to face today conditions similar to those faced by Mexico in 1994 at the time of its serious financial crisis. This paper identifies a number of macroeconomic and financial indicators, constructs a profile of the Mexican economy at the time of the crisis, and then compares these with the conditions in other major emerging market economies in Latin America and Asia today in order to determine the extent to which they resemble those of Mexico at the time of the 1994 crisis. The conclusion is reached that macroeconomic and financial indicators cannot by themselves predict Mexican-style financial crises. In today's world of highly integrated capital markets, any anticipation of financial unsustainability can lead to a massive capital outflow from the nation and trigger a crisis, with the catalyst usually being a worsening political problem. The usefulness of the indicators discussed is in providing a profile of the financial condition of the nation, evaluating the potential danger of a financial crisis, anticipating the depth of the crisis if one arises, and pointing to the precautions that a nation can take in trying to avoid a crisis or reduce its severity if one does occur.     

Country spreads and emerging countries: Who drives whom?

This paper attempts to disentangle the intricate relation linking the world interest rate, country spreads, and emerging-market fundamentals. It does so by using a methodology that combines empirical and theoretical elements. The main findings are: (1) US interest rate shocks explain about 20% of movements in aggregate activity in emerging economies. (2) Country spread shocks explain about 12% of business cycles in emerging economies. (3) In response to an increase in US interest rates, country spreads first fall and then display a large, delayed overshooting; (4) US-interest-rate shocks affect domestic variables mostly through their effects on country spreads; (5) The feedback from emerging-market fundamentals to country spreads significantly exacerbates business-cycle fluctuations.     

VaR performance during the subprime and sovereign debt crises: An application to emerging markets

Highly volatile scenarios, such as those provoked by the recent subprime and sovereign debt crises, have questioned the accuracy of current risk forecasting methods. This paper adds fuel to this debate by comparing the performance of alternative specifications for modeling the returns filtered by an ARMA-GARCH: Parametric distributions (Student's t and skewed-t), the extreme value theory (EVT), semi-nonparametric methods based on the Gram–Charlier (GC) expansion and the normal (benchmark). We implement backtesting techniques for the pre-crisis and crisis periods for stock index returns and a hedge fund of emerging markets. Our results show that the Student's t fails to forecast VaR during the crisis, while the EVT and GC accurately capture market risk, the latter representing important savings in terms of efficient regulatory capital provisions.