Currency crisis contagion, capital flows, and sovereign ratings: empirical studies of emerging markets

Abstract

Followed by the introduction, we begin the thesis by focusing on providing a quantitative indicator of the currency crisis contagion during the 1997-98 East Asian crisis. The severity of contagion is measured using a state-space model and a technical apparatus known as the Kalman filter. The results show that the contagion level is exceptionally high during the peak of the Asian crisis from June 1997 to January 1998. Further econometric tests were carried out to identify whether the crisis is transmitted to countries linked through trade or to countries characterized by macroeconomic similarities. The results indicate that the macroeconomic similarity dominates trade linkage as the major crisis transmission channel. Further, the high level of domestic claims which were financed by foreign capital inflows were shown to be the most significant factor in explaining crisis contagion in 1997-98. The next part of the thesis develops and implements a method for fore-casting capital flows to emerging markets. We provide capital flow forecasts to thirty-two developing countries using a vector autoregressive (VAR) framework based on the underlying fundamental factors driving capital flows. We also use our estimated models to carry out simulation exercises for the behaviour of capital flows under various economic scenarios. In the following part of thesis, using an unobserved components model and maximum likelihood Kalman filtering estimation, we separate out permanent and temporary components of capital flows. Based on these models, and using monthly data up to December 2000, forecasts of various capital flows are presented for the period January 2001 to December 2003. The results of the time series-based forecasts are then compared to those obtained using the fundamentals-based approach