As we have previously explained, our systemic impact variable was constructed based on the conditional probability of joint failures (CPJF), which stems from the same dataset used in the probit regressions, potentially leading to endogeneity. However, we argue that the CPJF matrix, which identi…es the tail linkages across countries in the same region, does not change dramatically between periods. Nonetheless, in order to check for any potential endogeneity, we now construct our systemic impact variable at time t by using data in[t 240; t 1] to re-estimate the CPJF’s.
As was discussed in section 2, when constructing the CPJF it is necessary to specify the number of high order statistics k (recall from Section 2 that we choose k = 45 when using the entire sample of 337 months). By using an identical procedure as in section 2, we …nd that k = 40 in the out-of-sample case.17 We then compare the real data at timet with the thresholds and identify which countries experience a tail event; this leads to the variables Crisisit. The next step is to use equation (6) to calculate our systemic impact variable, which is now entirely constructed from past information, thereby eliminating any
17It is quite remarkable that the corresponding probability level is40=240 = 16:7%, which is quite close to the one used for the entire sample13:3%. The Hill plots for these new results are available upon request.
22
Table 5: Panel Probit for all three regions with Moving Window CPJF; 1999M2 - 2007M9
Asia Western Hemisphere Africa
5:1 mfx 5:2 mfx 5:3 mfx 5:4 mfx 5:5 mfx 5:6 mfx
Di¤ Dom. Creditt 3.26 3.67 7.84 1.4 7.26 1.8
(0.44) (0.56) (3.84) (5.10)
Di¤ in Liquidityt 0.006 0.02 2.6 -0.006 0.002 0.04 26.3 0.04 26.3
(0.98) (2.12) (-1.51) (0.57) ( 7.92) ( 3.45)
Di¤ GDP growtht 0.75 1.42 0.3 4.21 3.58 4.39 2.72
(0.85) (1.79) (1.61) (1.21) (0.68) (0.53)
Di¤ CPI In‡ationt 0.12 0.18 0.33 19.6 0.24 18.6 0.07 0.07
(0.89) (1.32) (5.35) (10.5) (0.65) (0.75)
Di¤ Financial. Int.t 0.07 0.8 -0.01 0.51 1.5
( 1.73) (-1.10) (2.53)
Di¤ Gov. Budgett 4.51
( 1.29)
FDI in‡owst 0.21 -0.26 1.65 1.0
(0.84) (-1.23) ( 4.01)
Portfolio in‡owst 0.03 0.5 0.16 1.7 1.06
( 4.60) (2.85) (0.70)
Debt in‡owst 0.02 0.09 2.35
(4.61) (1.02) ( 0.61)
Systemic Impact[t 240;t 1] 1.38 1.0 1.52 1.1 -1.14 -1.37 2.80 3.4 2.59 4.3
(3.09) (2.90) (-0.79) (-0.82) (5.30) (4.50)
Observations 713 713 470 470 504 504
McFadden R2 0.07 0.08 0.12 0.13 0.52 0.50
Notes: Dependent variable is a Crisis dummy; model includes a constant; *, **, *** are 10%, 5%, 1% sig. levels;
23
potential endogeneity in our probit model. We distinguish between the approach in this out-of-sample section and the entire sample approach of section 4, by referring to them as the “out-of-sample” and the “in-sample” approach, respectively. Before proceeding with the results, we must mention that the onset of a banking crisis variable could not be included in this out-of-sample analysis due to collinearity with the constant, since during this new sampling period there are no onsets of banking crisis.
For the sake of conciseness, Table 5 only presents the results for ourde facto measures of …nancial openness. First, our systemic impact variable is still highly signi…cant for Asia and Africa but not for the Western Hemisphere economies; this corroborates the pattern found in section 4. When it comes to …nancial integration, we con…rm our previous …nd-ings that Asian economies bene…t from integrating into world capital markets, whereas Western Hemisphere economies are not hurt nor do they bene…t from …nancial integration.
Previously, we had found that …nancial integration did not have any e¤ect on currency crises for African economies. However, Table 5 (speci…cation 5:5) indicates that this vari-able has a positive and signi…cant e¤ect even after controlling for systemic impact This indicates that these "developing" economies are clearly not ready to integrate into world capital markets. When it comes to the di¤erent types of capital ‡ows, the patter found in Section4 remains the same.
We also analyze the predictive power of our model by lagging our exogenous variables.
We follow the methodology described above by including the "out-of-sample" systemic impact variable, and by only focussing on de facto …nancial integration into world capital markets. Through Table 6 we can con…rm, for all regions, that our lagged systemic impact variable does have predictive power for currency crises. Lagged …nancial integration does not have any predictive power in relation to the probability of a currency crisis in Asia and the Western Hemisphere. However, for African economies a one standard deviation increase in …nancial integration in the previous period (t 1)will increase the probability of a currency crisis (in periodt) by over2%; as was found in Table 5.
The e¤ects of the di¤erent types of capital in‡ows vary by region. For Asian economies, a large in‡ow of portfolio-type capital in the previous period (t 1)will reduce the prob-ability of a currency crisis in period t. The result that medium-term capital ‡ows can be bene…cial for Asian economies still stands, since these economies will bene…t from the further development of bond markets. For the Western Hemisphere economies, the results reported in column6:4indicate that FDI in‡ows help reduce the probability of a currency crisis; while a large in‡ow of portfolio-type capital will increase this probability one period in the future. Similarly, African economies bene…t from higher and more sustained levels
24
Table 6: Panel Probit for all three regions with all variables lagged by one period (i.e. one month); 1999M2 - 2007M9
Asia Western Hemisphere Africa
6:1 mfx 6:2 mfx 6:3 mfx 6:4 mfx 6:5 mfx 6:6 mfx
Di¤ Dom. Creditt 1 5.88 5.42 1.60 1.96
(0.96) (0.92) (1.60) (1.59)
Di¤ in Liquidityt 1 0.01 1.8 0.02 2.9 -0.007 0.003 -0.01 -0.03 -39.5
(2.60) (4.14) (-1.48) (0.75) (-1.58) (-3.56)
Di¤ GDP growtht 1 1.70 1.74 1.74 0.69 -9.40 -2.5 -10.41 -2.1
(0.57) (0.62) (0.85) (0.40) (-2.36) (-3.56)
Di¤ CPI In‡ationt 1 -0.18 -0.20 0.38 24.5 0.32 19.6 0.10 0.08
(-1.13) (-1.20) (2.24) (3.32) (1.05) (0.93)
Di¤ Financial. Int.t 1 -0.06 -0.008 0.23 2.2
(-1.44) (-0.50) (2.13)
Di¤ Gov. Budgett 1 -8.81 -25.2
(-2.06)
FDI in‡owst 1 -0.23 -0.38 -2.2 -3.36 -2.2
(-1.05) (-2.79) (-3.96)
Portfolio in‡owst 1 -0.03 -0.3 0.36 2.6 0.07
(-4.07) (3.07) (0.05)
Debt in‡owst 1 0.002 0.07 -0.72
(0.31) (0.51) (-0.18)
Systemic Impact[t 240;t 1]t 1 1.10 0.8 1.14 0.8 3.07 1.3 3.24 1.3 1.12 4.3 0.77 2.2
(1.99) (2.15) (2.57) (4.66) (9.22) (5.59)
Observations 713 713 470 470 623 504
McFadden R2 0.08 0.09 0.15 0.16 0.12 0.22
Notes: Dependent variable is a crisis dummy; model includes a constant; *, **, *** are 10%, 5%, 1% signi…cant levels respectively;
25
of FDI. Though not reported, for Asian economies the lagged value of trade openness is negatively signi…cant (at the10%-level) with a marginal e¤ect of1% vis-à-vis reducing the probability of a currency crisis "today". For Western Hemisphere economies, we also …nd that the trade openness variable is highly signi…cant but this time at1%, with a marginal e¤ect of13:5% (excluding Canada does not change the results).
6 Robustness
Our analysis in Section4was regional, where the choice of pooling data is reasonable since systemic risk is, as far as we …nd, regional. Nonetheless, as a robustness check we reproduce the same analysis as in section4, but this time at the country level. The signi…cance of the di¤erent types of capital in‡ows still holds at the country level, but only for South Korea, Malaysia, and Singapore, while our systemic impact variable remains highly signi…cant at the country level. However, for Western Hemisphere economies we …nd that our systemic impact variable is only signi…cant for Argentina and Mexico. This result mirrors the conclusions reached through Table 15, namely that linkages between crises in the Western Hemisphere economies is in general weak. Interestingly, this is in contrast to the results found in Section4:2, where we found that that the systemic impact variable is signi…cant.
The di¤erence might due to the data pooling e¤ects.
We also conduct a second robustness check by changing the threshold level. As we explained in Section 2:3, when we construct the CPJF we choose, according to the Hill plot procedure, the top13:3%order statistics, which we then use to construct our systemic impact variable. Theoretically, multivariate extreme value theory (MEVT) ensures that the estimation of the CPJF is insensitive to the choice of threshold. However, this property does not necessarily ensure a stable result for the probit model; it is thus necessary to check the robustness by changing the threshold.
For our new threshold we choose a level of 6:7%, which is the threshold used by Eichen-green et al. (1996) under normality assumptions ( + 1:5 ). Obviously, such a threshold choice is more restrictive vis-à-vis the de…nition of a tail event (i.e. it leads to an un-derestimation of risk). It is worth pointing out that by shifting the threshold level, the dependent variable as well as our systemic impact variable also change; however, changing the threshold does not change any of the other control variables. The results from this last exercise point to three major di¤erences: First, our systemic impact variable is no longer signi…cant for Western Hemisphere economies. This result, alongside the evidence stemming from the individual country results, con…rms the fact that pooling data for the
26
Western Hemisphere bears potential estimation problems, especially since (as we have pre-viously argued) the economies in this region of the world are tail independent in terms of currency crises. Hence, we cannot consider the signi…cance of the systemic impact in section 4:2 as robust.
Our second major di¤erence relates to …nancial integration, which is now not signi…cant for any of the regions in our sample. This insigni…cance indicates that when we consider a more restrictive level of tail events, we can only bene…t from …nancial integration policies by reducing information asymmetry (i.e. by taking into account systemic impact). The third major di¤erence relates to the e¤ects of the various types of capital ‡ows. More speci…cally, if we solely relied on the6:7%threshold results, we would conclude that African economies could bene…t from all types of capital ‡ows, since they all enter signi…cantly and negatively, which of course points to a di¤erent direction as compared to the results in Section 4. Accordingly, we can only conclude that our systemic impact variable is insensitive to the choice of threshold. Therefore, in order to gain a better understanding on the consequences of open capital markets in relation to the reduction of currency crises, it is imperative to specify the risk level precisely as we have done in this paper.
7 Conclusion
This paper has contributed to the understanding of …nancial openness in terms of currency crises. Throughout the paper we have also argued that "cross-market rebalancing" is an important source of joint crises, where the standard approach to capturing systemic impact only considers whether at least one of the other economies in the same region is su¤ering a crisis. Intuitively, however, countries may have di¤erent links during crises periods.
Therefore, in order to incorporate the di¤erent levels of connections between countries, we need as a …rst measure, the dependence between di¤erent economies during periods of extreme values. Accordingly, we derived the conditional probability of joint failure (CPJF), which is an informative measure of "tail-dependence".
By employing monthly data for23economies spanning di¤erent regions of the world for the period 1978 2007, a battery of statistical and empirical tests reject, at high levels of con…dence, tail-independence at the regional level. However, at the global level (i.e. joint crises across regions), we only …nd tail independence. Furthermore, the degree of within region dependency can be ranked: African economies show the most tail-dependence, fol-lowed by Asia. Interestingly, we …nd that the Western Hemisphere economies are the most tail-independent when it comes to the transmission of currency crisis. We then used probit
models to compare our newly-constructed systemic impact variable with the standard ap-proach in the literature of treating all neighboring economies equally. Firstly, our systemic impact variable helps to improve the …t of the model. Secondly, our variable displays higher economic signi…cance in evaluating the possibility of a currency crisis, particularly in re-gions demonstrating strong or at least some tail-dependence such as in Asia and Africa.
In a more tail-independent region such as the Western Hemisphere, the e¤ect is weaker but still signi…cant. Therefore, our probit estimation results con…rm that the probability of a currency crisis in a given economy increases signi…cantly due to the systemic impact of crises in a region, especially in regions that are more "tail-dependent".
One of the main objectives of the paper was to …nd out whether integration into world (capital) markets increases …nancial instability. By taking systemic impact into account we observe thatde facto …nancial openness helps to reduce the occurrence of currency crises.
In order to clarify further the pros and cons of …nancial openness, we decomposed it into the di¤erent types of capital in‡ows. This decomposition shows that African and Western Hemisphere economies bene…t from "persistent" FDI in‡ows; while Asia is the only region that bene…ts from a steady increase in portfolio-type in‡ows. We also found that higher exchange market pressure is associated with a stronger acceleration of CPI in‡ation, and expansionary …scal policy. Western Hemisphere economies behave di¤erently from Asian economies in relation to the impact of GDP growth, since Western Hemisphere economies can reduce the probability of a currency crisis by increasing their GDP growth in a more stable fashion. Furthermore, lack of international reserves and higher levels of CPI in‡ation can have quite damaging e¤ects as far as excessive pressure in their respective currencies.
For African economies we …nd that lower in‡ation, improvements in the government budget balance, and higher levels of international reserves, bene…t these economies by helping reduce the probability of a currency crisis. We also controlled for the onset of banking crises, and our results indicate that for more tail-dependent regions such as Asia and Africa, currency crises are mainly driven by speculative attacks rather than by the onset of banking crises. On the other hand, for a more independent region such as the Western Hemisphere, the onset of a banking crisis is a signi…cant source of currency crises. All in all, our systemic impact variable, by accounting for information asymmetry and the level of speculative attacks in a given region, provides a proper instrument for evaluating the systemic impact of …nancial crises.
In the introduction to this paper we asked three interrelated questions: (i) How can we best capture the systemic linkages of crises? (ii) Is the systemic risk of currency crisis a regional or a global phenomenon? (iii) By controlling for systemic impact, do
28
other mechanisms like …nancial openness increase the probability of a currency crisis? The answers to those questions are now clear: (i) the CPJF measures the systemic linkages between …nancial crises and helps to improve our understanding of this e¤ect. Furthermore, our systemic impact variable, which is based on the CPJF, provides a more informative measure for the systemic impact of crises to a speci…c country; (ii) systemic risk does exist, but only from (regional) neighbors;(iii)by taking into account the systemic impact of crises, de facto …nancial openness helps reduce the probability of a currency crisis.
Given these answers, several important policy implications emerge from the empirical results presented in this article. First, once a crisis begins in a given region, the interna-tional community should be prepared to support other economies in the region. Second, there is a need for governments to undertake transparent monetary and …scal policies in or-der to reduce information asymmetry, especially in relation to the private sector, and help the latter form expectations that are closer to those of the monetary and …scal authorities.
Third, using a one-size-…ts-all approach to capital account management is not advisable, since the e¤ects of di¤erent types of capital vary by region. We have shown that all capital is not created equal, and that the e¤ects vary by region. If capital controls are to be used, they should be targeted at short-term capital, while at the same time allowing medium to long-term capital into an economy. This approach will, at the very least, help reduce economic imbalances. Fourth, the results indicate that countries must pursue monetary policy aiming at "price stability" through, for example, a ‡exible in‡ation target that takes into account systemic risk, in order to mitigate a currency crisis. Lastly, though countries can prevent the onset of a currency crisis by pursuing polices that result in sound internal and external macroeconomic balances, currency crisis can still spread to such countries;
therefore, the prevention, resolution, and management of the systemic impact of the crises may require more thoroughly coordinated actions among the di¤erent regional economies.
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