This article contributes to the debate on hedge funds and exchange rates in Thailand and Malaysia. It examines causal relations using a new Granger non-causality procedure proposed by Toda and Yamamoto (Journal of Econometrics, 66, 225-50, 1995). Monthly observations are utilized over a sample period from January, 1994 to April, 2002. The results show that the funds lead Thai baht for the crisis period. The results also reveal that the funds lead Malaysian ringgit for the pre-crisis period.Hedge Funds; Exchange Rates; Granger Non-Causality; Thailand; Malaysia

Azman-Saini, W.N.W.

English

Research Papers in Economics

  1 
HEDGE FUNDS, EXCHANGE RATES AND CAUSALITY:  
EVIDENCE FROM THAILAND AND MALAYSIA 
 
 
W.N.W. Azman-Saini* 
 
 
October, 2006 
 
 
Abstract 
This  article  contributes  to  the  debate  on  hedge  funds  and  exchange  rates  in 
Thailand and Malaysia. It examines causal relations using a new Granger non-
causality procedure proposed by Toda and Yamamoto (Journal of Econometrics, 
66, 225-50, 1995). Monthly observations are utilized over a sample period from 
January, 1994 to April, 2002. The results show that the funds lead Thai baht for 
the crisis period. The results also reveal that the funds lead Malaysian ringgit for 
the pre-crisis period.   
 
 
JEL Classification:  G2, C5, F3  
 
Keywords:  Hedge Funds, Exchange Rates, Granger Non-Causality. 
 
Affiliation:    * Department of Economics, 
Universiti Putra Malaysia,  
43400 Selangor,  
Malaysia. 
 
Words:     1800  
 
Correspondence:  Wan Azman Saini Wan Ngah (W.N.W. Azman-Saini),  
Economics Division (PGR),  
School of Social Science,  
University of Southampton,  
Southampton  
SO17 1BJ, UK.  
E-mail: wazman@soton.ac.uk 
 
 
 
 
 
 
   2 
HEDGE FUNDS, EXCHANGE RATES AND CAUSALITY:  
EVIDENCE FROM THAILAND AND MALAYSIA 
 
 
I.  INTRODUCTION 
There is increasing interest in the activity of hedge funds. In recent years, there 
were several events associated with hedge funds activities. The attack on the 
sterling in 1992, the global bond rally in 1993, the Asian currency crisis of 1997 
and the Long Term Capital Management crisis were few examples. Compared to 
other  investment  institutions,  hedge  funds  have  no  restriction  on  the  use  of 
leverage,  short-selling  and  derivatives  than  the  more  regulated  investment 
institutions.  This  allows  them  to  follow  investment  strategies  that  are 
significantly different from that of traditional investment institutions. 
 
Despite a series of earlier events linked to hedge funds, it was not until 
the Asian currency crisis that regulators took active interest in their activities. 
The crisis which witnessed massive and abrupt falls of Asian currencies had led 
Mahathir  Mohamad  (i.e.  former  Prime  Minister  of  Malaysia)  to  voice  out  his 
displeasure on hedge funds activities for selling short the currencies and brought 
significant pressure on them (Mohamad, 1997). The funds are also criticized for 
dealing  in  thin  markets  with  substantial  volume,  herding,  colluding  and 
manipulating. Although  recent  studies fail  to  find  evidence  that  hedge  funds 
were  responsible  for  the  crisis,  an  interview  with  Stanley  Druckermiller  (i.e. 
former head of the Quantum Fund) revealed that there were short positions in 
the baht and ringgit.1   
 
 
 
                                                 
1 The Quantum’s year-to-date returns climbed from 3.2% at the end of the first quarter to 22% as of 
Sept. 3, 1997 (Wall Street Journal, Sept. 5, 1997, p. C1).   3 
A few studies have assessed the link between hedge funds and exchange 
rates. Most of the studies focused on estimating individual funds exposure by 
inferring their position from return data. For example, using monthly data on 27 
funds, Fung and Hsieh (2000) observe that most of them had a sizeable gain in 
July 1997 when the Thai baht was devalued. However, they conclude that the 
gain  was  attributed  to  long  positions  in the US  equity  market.  2 Brown  et al. 
(1998) examine whether the funds prompted the crisis by taking short positions 
in Asian currencies. Using the Sharpe-style analysis and a sample of ten global 
funds, they find that the aggregate exposure of the funds to the ringgit varied 
considerably.  However,  there  was  no  relationship  between  the  estimated 
changes  in  funds  exposure  and  the  changes  in  the  value  of  the  currency. 
Eichengreen et al. (1998) argue that there is little evidence to believe that funds 
are  more  likely  to  overwhelm  a  market  than  other  large  traders  such  as 
commercial  banks,  investment  banks,  insurance  companies,  and  corporations. 
The funds are not able to manipulate a market than any of these entities and 
there is no evidence that funds used positive feedback trading strategies during 
the  crisis  in  1997.  Brealy  and  Kaplanis  (2001),  however,  argue  that  fund’s 
exposures  which  are  inferred  from  fund’s  return  should  be  interpreted 
cautiously. As the funds are commonly thought to make frequent changes in 
their exposures, the estimated coefficient should be interpreted as fund’s average 
exposures over the estimation period.  
 
This article contributes to the literature on the relationship between hedge 
funds and exchange rates in two aspects. First, this study extends the literature 
by examining the causal relationship between hedge funds and exchange rates.  
Existing studies focus mainly on estimating the individual fund’s exposure on 
currencies. Nevertheless, the interest of researchers is not only to assess their 
                                                 
2 They also found that the funds exposure were significant during the ERM crisis in 1992, the global 
bond rally in 1993/1994. However, the funds exposures were insignificant during the stock market 
crash of 1987 and the Mexican peso crisis in 1994. 
    4 
exposure, but they are more likely to know the causal patterns between these 
two  variables.  For  instance,  do  hedge  funds  activities  lead  currencies 
depreciation? However, this question remains unanswered and therefore, this 
study  fills  the  gap.    Secondly,  this  study  utilizes  a  new  methodology  which 
allows  causal  inferences  to  be  conducted  in  a  system  including  time  series 
processes that may be integrated as well as cointegrated. Toda and Yamamoto 
(1995) provide a simplistic approach for assessing causal relations regardless of 
order  of  integration  and/or  the  cointegration  rank  in  a  VAR  system.  This 
methodological approach is useful because it bypasses the need for potentially 
biased pre-tests for unit roots and cointegration, common to other formulations. 
The rest of the paper is structured as follows. Section II discusses the data and 
empirical methodological issues while Section III presents the empirical results. 
Section IV concludes. 
 
II.  DATA AND EMPIRICAL METHODOLOGY 
Monthly observations for a sample from January 1994 to April 2002 are utilized.3 
The  pre-1994  data  are  avoided  due  to  the  measurement  biases.4  The 
macro/global funds returns are used to proxy hedge funds activities. This study 
utilizes five different sources of data which are commonly used in the literature 
namely,  Investor  Force  Securities  Inc.  (IFS),  Hedge  Fund  Research  Inc.  (HFR), 
Hennesse Group LLC. (HEN), Credit Suisse First Boston/Tremont Index LLC. (TRE) 
and Zurich Capital Market Inc. (ZUR). End of month spot bilateral exchange rates 
vis-à-vis  U.S.  dollar  are  from  International  Financial  Statistic  and  expressed  as 
domestic currency per unit of U.S. dollar. The sample period is divided into two 
sub-samples. The pre-crisis period covers from January 1994 to June 1997 during 
which the currencies were relatively stable. The crisis period continues from July 
                                                 
3 In the case of Malaysia, the post- August 1998 period is avoided due to the imposition of capital 
control which almost completely closed the financial market to foreigners. 
4 For a complete description of these biases, refer to Fung and Shieh (2002). 
   5 
1997 through April 2002. This period was characterized by massive currencies 
depreciation.  
 
It is well known that in the context of integrated series, the conventional 
application of the F-test (i.e. in a standard VAR model) is invalid5. Moreover, the 
F-test is not valid unless the variables are cointegrated in levels. Recently, an 
alternative approach which utilizes the modified wald (MWALD) test for testing 
linear restriction on the parameters was proposed by Toda and Yamamoto (1995) 
- hereafter, TY. The test has an asymptotic χ2 distribution when a VAR (k + dmax) 
is estimated where dmax is the maximum degree of integration suspected to occur 
in  the  system. Toda  and Yamamoto  point  out  that, for d=1,  the lag selection 
procedure is always valid since k≥1=d. If d=2, then the procedure is valid unless 
k=1. Moreover, the MWALD statistic is valid regardless whether a series is I(0), 
I(1) or I(2), non-cointegrated or cointegrated of an arbitrary order. In addition, 
the  MWALD  test  has  a  comparable  performance  in  size  and  power  to  the 
likelihood ratio (LR) and Wald tests (Zapata and Rambaldi, 1997) 
 
   Rambaldi and Doran (1996) demonstrated that this testing procedure can 
be easily constructed using a seemingly unrelated regression (SUR) framework. 
Following  TY  non-causality  test,    these  variables  can  be  causally  linked  in  a 
system as follows:6 
 






+ 





+ 





+ 





+ =








−
−
−
−
−
−
EX
HF
4
3 t
3 t
3
2 t
2 t
2
1 t
1 t
1 0
t
t
EX
HF
EX
HF
EX
HF
EX
HF
ε
ε
α α α α α     (1) 
 
where α0 is an identity matrix and E( ) t ε = [
t t EX HFε ε ]′=0 and E( ) Σ ε ε = ' t t . For 
example, if k=2 and dmax=1, a causality from EX to HF can be established through 
                                                 
5 Spurious regression due to non-standard distribution of the test statistics, see Toda and Phillips 
(1993). 
6 Assuming 3-order VAR, where HF=hedge funds; EX=exchange rates.    6 
rejecting the null hypothesis of  1 t EX −  and  2 t EX −  are jointly equal to zero in the 
first equation of the above system. A similar procedure can be used to test the 
causality from HF to EX by establishing a significance of the MWALD statistic 
for a group of lagged HF variables in the second equation of the system.  
 
III. EMPIRICAL RESULTS 
Applying the TY procedure outlined in the previous section, the nature of causal 
linkages between the hedge funds and exchange rates is examined. Since the 
appropriate lag length is important to identify the true dynamic of the model, the 
Akaike Information Criterion (AIC) and Schwarz Bayesian criterion (SBC) lag 
selection criteria  are  used  to determine the  optimal lag  structure  of  the  VAR 
system. In most cases, the lags suggested by AIC and SBC are the same. Due to 
the importance of serially uncorrelated residuals, higher lag is chosen whenever 
AIC and SBC suggest different lags.  
 
The  implementation  of  the  TY  procedure  involves  estimating  system 
Equation (1) in the level form. The results are reported in Tables 1 and 2 for the 
baht and ringgit, respectively.   
 
<INSERT TABLE 1> 
 
 
Panels A and B report results for the pre-crisis period and crisis period, 
respectively. Using a 10 percent significant level as a testing criterion, we fail to 
establish the causal relationship from the hedge funds to the baht for the pre-
crisis period. In all cases, the MWALD statistics are too small to reject the null. 
However, there are mixed evidence for the crisis period. In four cases, the null of 
non-causality  are  rejected.  Generally,  the  findings  are  suggestive  that  hedge 
funds Granger-cause baht.  
 
<INSERT TABLE 2>   7 
 
Results  in  table  2  suggest  that  there  is  a  strong  evidence  of  causality 
running from hedge funds to ringgit for the pre-crisis period. In four cases, the 
null hypothesis of non-causality can be rejected at the 10 percent level. Thus, we 
can safely conclude that the funds performance contains leading information for 
the ringgit. One of the implications of this finding is that, the funds activities 
contain useful predictive information on the ringgit movements. However, the 
results of the crisis period show that no causal direction from hedge funds to 
ringgit can be established. The MWALD statistic is too small in order to reject the 
null. 
 
IV. CONCLUSION  
This  study  contributes  to  the  debate  on  hedge  funds  and  exchange  rates  in 
Thailand and Malaysia. Monthly observations are utilized for a sample period 
from  1994  to  2001.    In  order  to  better  understand  the  issue,  two  sub-sample 
periods are created. The pre-crisis period covers from January 1994 to June 1997 
and the crisis period spans from July 1997 to April 2002. A new Granger non-
causality  procedure  by  Toda  and  Yamamoto  (1995)  is  utilized.    Among  the 
findings of interest is that the hedge funds Granger-cause baht during the crisis. 
However, there is no evidence that the funds lead ringgit during the same period 
which suggests that hedge funds activities did not exert significant influence on 
the ringgit. However, the findings for the pre-crisis period suggest that the funds 
contain useful predictive information only on the ringgit.  
 
 
 
 
 
 
   8 
REFERENCES 
 
Brealy, R. and Kaplanis, E. (2001) Hedge funds and financial stability: an analysis 
of factor exposures, International Finance, 4(2), 161-187.  
 
Brown,  S.,  Goetzmann,  W.  and  Park,  J.  (2000)  Hedge  funds  and  the  asian 
currency crisis, Journal of Portfolio Management, 26(4), 95-101. 
 
Eichengreen, B., Mathieson, D., Chadha, B., Jansen, A., Kodres, L. and Sharma, S. 
(1998)  Hedge  funds  and  financial  market  dynamics,  International 
Monetary Fund, Occasional Paper 166, Washington, DC.   
 
Fung, W. and Shieh, D.A. (2000) Measuring the market impact of hedge funds 
Journal of Empirical Finance, 7, 1-36. 
 
Fung, W. and Shieh, D.A. (2002) Hedge-fund benchmarks: information content 
and biases, Financial Analyst Journal, 58(1), 22-34. 
 
Mohamad. M. (1997) Highwaymen of the Global Economy, Wall Street Journal, 
9/23. 
 
Rambaldi,  A.N.  and  Doran,  H.E.  (1996)  Testing  for  granger  non-causality  in 
cointegrated  systems  made  easy,  Working  paper  in  Econometrics  and 
Applied Statistics No 88, department of Econometrics, University of New 
England. 
 
Toda,  H.  Y.  and  Phillips,  P.C.B.  (1993)  Vector  autoregressions  and  causality, 
Econometrica, 61, 1367-1393. 
 
Toda,  H.  Y.  and  Yamamoto,  T.  (1995)  Statistical  inference  in  vector 
autoregression with possibly integrated processes, Journal of Econometrics, 
66, 225-250. 
 
Wall Street Journal, Sept. 5, 1997, p. C1. 
 
Zapata, H.O. and Rambaldi A.N. (1997) Monte carlo evidence on cointegration 
and causation, Oxford Bulletin of Economics and Statistics, 59(2), 285-298. 
 
 
 
 
 
 
 
   9 
Table 1: The results of Granger non-causality test for the Thai baht.   
  Null Hypothesis 
  HEN−/−>THB  IFS−/−>THB  HFR −/−>THB  TRE−/−>THB  ZUR−/−>THB 
           
  A: Pre-crisis period (January 1994 to June 1997) 
MWALD  0.3254  0.9569  2.1255  0.9141  0.4121 
p-value  0.5683  0.3279  0.1448  0.3390  0.5208 
Lag  1  1  1  1  1 
           
  B: Crisis Period (July 1997 to April 2002) 
MWALD  9.0693*  5.3672*  3.5207*  2.6882  5.0534* 
p-value  0.0107  0.0683  0.0606  0.1010  0.0245 
Lag  2  2  1  1  1 
           
Notes:    
* indicate rejection of null hypothesis at the 10% significant level.  
The (−/−>) and (−−−>) indicate does not Granger-cause and Granger-cause, respectively. 
THB = Thai baht  
 
 
 
 
 
 
Table 2: The results of Granger non-causality test for the Malaysian ringgit.  
  Null Hypothesis 
  HEN−/−>MYR  IFS−/−> MYR  HFR−/−>MYR  TRE−/−> MYR  ZUR−/−>MYR 
           
  A: Pre-crisis period (January 1994 to June 1997) 
MWALD  12.8937*  9.0464*  11.5756*  2.49104  24.7525* 
p-value  0.0003  0.0026  0.0006  0.1145  0.0000 
Lag  1  1  1  1  1 
           
  B: Crisis Period (July 1997 to August 1998) 
MWALD  1.8081  0.4663  1.3927  1.5880  1.4931 
p-value  0.1787  0.4946  0.2379  0.20761  0.2217 
Lag  1  1  1  1  1 
            
Notes:    
* indicate rejection of null hypothesis at the 10% significant level.  
The (−/−>) and (−−−>)  indicate does not Granger-cause and Granger-cause, respectively. 
MYR = Malaysian ringgit  
 

Hedge funds and financial market dynamics, International Monetary Fund, Occasional Paper 166,

Hedge funds and financial stability: an analysis of factor exposures,

Hedge funds and the asian currency crisis,

Hedge-fund benchmarks: information content and biases,

Measuring the market impact of hedge funds

Monte carlo evidence on cointegration and causation,

Statistical inference in vector autoregression with possibly integrated processes,

Testing for granger non-causality in cointegrated systems made easy, Working paper in Econometrics and Applied Statistics No 88, department of Econometrics,

Vector autoregressions and causality,

Hedge funds, exchange rates and causality: Evidence from Thailand and Malaysia

Hedge funds, exchange rates and causality: Evidence from Thailand and Malaysia

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