Revisiting East Asian exchange rates: the same spirit under a different sky

Abstract

The transmission of shocks among East Asian currencies following the 1997 crisis has been a widely investigated topic using different methodologies. Some studies have utilized linear vector autoregression (VAR) and its tools, such as impulse responses and forecast error variance decompositions. A few on the other hand, focusing on the nonlinearities in exchange rates, employed Markov-switching VAR (MS-VAR) framework, thus attempted to capture asymmetries linked with different regimes. A major problem of typical MS-VAR models, however, lies in the lack of economic intuition unless these are converted into a structurally identifiable form. This article extends such studies by using a different apparatus: first, it combines Markov switching and structural identifying restrictions in a vector autoregression (MS-VAR) framework, thus providing regime-dependent impulse response functions to currency shocks. Second, it also provides impulse responses to shocks associated with regime changes. Empirical findings show that the responses to currency shocks under different regimes differ in terms of size and persistence. Among three currencies used in this study, Indonesian rupiah has been found most sensitive to regime shifts. On the other hand, leading role of Thai baht in affecting regional currency fluctuations has been confirmed.

Notes

¹ Moreover, Korea is not a member of ASEAN group.

² Equivalently, the link between the intercept ν and the mean of y_t can be established through the relationship μ(s_t ) = ν(s_t ){I − A ₁(s_t )− … −A_p (s_t )}⁻¹.

³ As the number of state-dependent parameters increases, so does the computational burden. Consequently, parsimony in modelling is justifed.

⁴ See also Hamilton (1990) for the univariate case.

⁵ Less parsimonious three-state models were also tried but no improvement in model performance was observed.

⁶ There are other variants of the shift function specification such as exponential and rational function, however, these are not used here as they do not affect the unit root test results.

⁷ The choice of the currencies used in this study is due to Zhang et al. (2004), which found the exchange rates of the East Asian economies relatively stable during the recent financial crisis with the exceptions of the Indonesian rupiah, the Korean won and Thai baht.

⁸ The monthly exchange rate regime classifications for these countries have been provided by Andrea Bubula.

⁹ Korea switched back to independent float as of September 2000; not shown here due to graphical space restriction.

¹⁰ Similar to Brazil, Mexico, Russia and Turkey, while in other countries such as Chile and Poland the move was more orderly.

¹¹ All computations were performed using the MS-VAR package and the state-dependent impulse response code has been obtained from Ellison's homepage. Detailed information regarding MS-VAR modelling in Ox can be found in Krolzig (1997, 1998).

¹² Further details are in the seminal paper by Hamilton (1990).

¹³ Under the new ordering scheme, responses of won and rupiah inter-change places such that middle panel now depicts the former and the bottom panel the latter, respectively.