The Contribution of Domestic and External Factors to Emerging Market Devaluation Crises: An Early Warning Systems Approach

56 Pages Posted: 16 Oct 2001

See all articles by Steven B. Kamin

Steven B. Kamin

Board of Governors of the Federal Reserve System

John W. Schindler

Board of Governors of the Federal Reserve System

Shawna L. Samuel

Princeton University - Woodrow Wilson School of Public and International Affairs

Date Written: September 2001

Abstract

In this paper, a modified "early warning system" (EWS) approach is developed to identify the roles of domestic and external factors in emerging market crises. Several probit models of financial crises were estimated for 26 emerging market countries. These models were used to identify the separate contributions to the probabilities of crisis of domestic and external variables. We found that, relative to domestic factors, adverse external shocks and large external imbalances contributed little to the average estimated probability of crisis in emerging market countries, but accounted for much more of the spikes in the probability of crisis estimated to occur during actual crisis years. We interpret these results to suggest that while, on average over time, domestic factors have tended to contribute to much of the underlying vulnerability of emerging market countries,adverse swings in external factors may have been important in pushing economies "over the edge" and into financial crisis. In consequence, the costs of giving up exchange rate flexibility through adoption of strongly fixed exchange rate regimes-e.g., currency boards or dollarization-may be quite high for some countries.

Keywords: currency crises, financial crises, devaluations, probit models

JEL Classification: F31, F32, F33

Suggested Citation

Kamin, Steven B. and Schindler, John W. and Samuel, Shawna L., The Contribution of Domestic and External Factors to Emerging Market Devaluation Crises: An Early Warning Systems Approach (September 2001). FRB International Finance Discussion Paper No. 711. Available at SSRN: https://ssrn.com/abstract=286279 or http://dx.doi.org/10.2139/ssrn.286279

Steven B. Kamin

Board of Governors of the Federal Reserve System ( email )

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John W. Schindler (Contact Author)

Board of Governors of the Federal Reserve System ( email )

Washington, DC 20551
United States
202-452-3889 (Phone)

Shawna L. Samuel

Princeton University - Woodrow Wilson School of Public and International Affairs ( email )

354A Wallace Hall
Princeton, NJ 08544-1021
United States
609-258-7376 (Phone)
609-258-5974 (Fax)

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