Markov Switching GARCH Models of Currency Crises in Southeast Asia

44 Pages Posted: 4 Apr 2003

See all articles by Celso Brunetti

Celso Brunetti

Board of Governors of the Federal Reserve System

Roberto S. Mariano

Singapore Management University

Chiara Scotti

University of Pennsylvania - Department of Economics

Augustine H.H. Tan

Singapore Management University - School of Social Sciences

Date Written: March 18, 2003

Abstract

This paper develops a model which is able to forecast exchange rate turmoil. Our starting point relies on the empirical evidence that exchange rate volatility is not constant. In fact, the modeling strategy adopted refers to the vast literature of the GARCH class of models, where the variance process is explicitly modeled. Further empirical evidence shows that it is possible to distinguish between two different regimes: "ordinary" versus "turbulence". Low exchange rate changes are associated with low volatility (ordinary regime) and high exchange rate devaluations go together with high volatility. This calls for a regime switching approach. In our model we also allow the transition probabilities to vary over time as functions of economic and financial indicators. We find that real effective exchange rate, money supply relative to reserves, stock index returns and bank stock index returns and volatility are the major indicators.

Keywords: Currency Crises, Markov Switching Models, Volatility

JEL Classification: F0, C5, G1

Suggested Citation

Brunetti, Celso and Mariano, Roberto S. and Scotti, Chiara and Tan, Augustine H.H., Markov Switching GARCH Models of Currency Crises in Southeast Asia (March 18, 2003). PIER Working Paper No. 03-008. Available at SSRN: https://ssrn.com/abstract=392460 or http://dx.doi.org/10.2139/ssrn.392460

Celso Brunetti (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Roberto S. Mariano

Singapore Management University ( email )

50 Stamford Rd.
Singapore 912409, 178899
Singapore

Chiara Scotti

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-3073 (Phone)
215-573-4217 (Fax)

Augustine H.H. Tan

Singapore Management University - School of Social Sciences ( email )

Tanglin P.O. Box 257
Singapore 912409
Singapore
+65 6822 0379 (Phone)
+65 6822 0101 (Fax)

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