Exchange Rate Economics: Theories and Evidence

13.2.3 Speculative index approaches
Speculative attack models and contagion 333
Most other empirical studies of speculative attack models focus on speculative
indices. For example,Eichengreen,Rose and Wyplosz (1995) [hereafter ERW]
use a panel of 22 OECD countries to analyse the ERM crises. They develop a
speculative pressure index along the lines of Girton and Roper’s measure of external
pressure. In particular,they construct a series emp which is the weighted average
of exchange rate and interest rate changes,and the (negative) of reserve changes.
If the index reaches two standard deviations above the mean a speculative attack is
identified. This variable is regressed on a set of macro-fundamentals. They find that
for non-ERM countries there is a significant difference for the relationship between
emp and fundamentals for non-ERM countries when they compare tranquil and
crises periods but no significant difference for non-ERM countries. They interpret
this as suggesting that ERM crises are driven by self-fulfilling events.
Flood and Marion (1997b) criticise the index used by ERW. In particular,they
argue that picking out extreme values in terms of the two standard error bounds will
miss out any anticipation of the crisis which is reflected in the indicators prior to the
crises. This simply means that the share of the predictable crisis in the sample may
be reduced. Second,if the subsequent post-crisis devaluation is viewed as credible
there may be little change in interest rate and reserves at the time of the crisis,
or they may revert back to pre-crisis levels quickly so the indicator in averaging
across these terms misses the crisis.
For example,Frankel and Rose (1996) use an annual data set,covering the
period 1971–92,for 105 developing countries and apply an event-study and probitregression
methods to a set of 16 macro indicators. In sum,they find that crises
tend to occur when output growth is low,growth of domestic credit is high,the
level of foreign interest rates is high and a low ratio of FDI debt is associated with
a high likelihood of a crash. Klein and Marion (1994) use a panel data set for
80 devaluations in South America over the period 1957–91. They find that the
monthly probability of abandoning a peg increases with real overvaluation and a
declining level of foreign assets – other factors that are important are: the degree
of openness,political factors and the amount of time the currency was pegged.
Variants of the speculative index approach have been used by others. For
example,Kaminsky and Reinhart (1996) use a variant to develop an ‘early warning
system’ of crises. In particular,a balance of payments crisis is identified when a
weighted average 7 of the monthly percentage depreciation in the exchange rate
and decline in reserves exceeds its mean by more than three standard deviations.
A more qualitative approach is used to define a banking crisis. Such a crisis arises
either when bank runs lead to the closure,merging or takeover by the public sector
of one or more financial institutions. Alternatively,in the case of no runs the crisis
occurs with the closure,merging,takeover or large-scale government assistance of
an important financial institution that marks the start of a string of similar outcomes
for other financial institutions. Kaminsky and Reinhart (1996) focus on 20 countries
in Asia,Europe,Latin America and the Middle East,over the period 1970 to
mid-1995. They find that in the 1970s there are a total of 25 balance of payments