Candidate: Fasika Damte Haile

Degree of: Doctor of Philosophy

Department: Economics

Title: Contagious Currency Crisis

Committee:
Dr. Susan Pozo, Chair
Dr. Matthew Higgins
Dr. Sisay Asefa
Dr. Ahmed M. Hussen

Date: December 12, 2002 10:00 a.m.-12:30 p.m.
2204 Dunbar

Abstract:
Currency crises, prior to the 1990s, were thought to be the result of inconsistencies between domestic economic policies and the exchange rate commitment. But the collapse of the European Exchange Rate Mechanism in 1992, the 1997 Asian crisis and the most recent crisis in Latin America have shifted the focus to models based on self-fulfilling expectations and on contagion. This has resulted in the development of different theoretical models suggesting different mechanisms by which contagion works. But there is relatively little empirical consensus on how crises spillover across countries. My dissertation is intended to fill in the void by testing for contagion and identifying the transmission channels for crises.
With this objective, I have estimated a panel probit model using quarterly data (1960-1998) from 37 advanced and emerging market economies. Two points make my work different from other studies on contagion. First, crises are identified by an alternative and relatively more objective method based on the extreme value theory. Second, I have allowed for crises to spread on a broader basis among i) major trade partners/competitors, ii) countries with strong financial linkages, iii) countries with similar macroeconomic fundamentals and/or iv) neighbors. Results from my estimations reveal that countries face currency crises because of unsustainable macroeconomic fundamentals and contagion. In all cases considered, contagion works via the trade channel. The results also show that the probability of a crisis in a given country increases as the number of its neighboring countries in crisis increases implying the presence of the neighborhood effects in the contagious spread of crisis. Contagion is regional and more specifically it operates through the trade channel. Because countries with sound fundamentals are still vulnerable to currency crisis, to prevent contagion countries need to consider alternative policies such as fixing their exchange rates collectively in a more firm and credible way. At the extreme, countries may adopt a regional currency, the scheme followed by some of the European countries in creating the Euro, to prevent contagion among members.

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