Fundamentals and Joint Currency Crises
European Central Bank (ECB); Centre for Economic Policy Research (CEPR) - International Macroeconomics
University of Maastricht - Limburg Institute of Financial Economics (LIFE)
Casper G. De Vries
Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Tinbergen Institute; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
ECB Working Paper No. 324
In this note we demonstrate that in affine models for bilateral exchange rates, the nature of return interdependence during crises depends on the tail properties of the fundamentals' distributions. We denote crisis linkages as either strong or weak, in the sense that the dependence remains or vanishes asymptotically. We show that if one currency return reaches crisis levels, the probability that the other currency breaks down as well vanishes asymptotically if the fundamentals' distributions exhibit light tails (like e.g. the normal). However, if the marginal distributions exhibit heavy tails, the probability that the other currency breaks down as well remains strictly positive even in the limit. This result implies that linearity and heavy tails are sufficient conditions for joint or contagious currency crises to happen systematically through fundamentals.
Number of Pages in PDF File: 31
Keywords: Financial crises, currency market linkages, fundamentals, heavy tails, asymptotic dependence
JEL Classification: G12, F31, G39, C49working papers series
Date posted: May 19, 2004
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