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YAŞAR UNIVERSITY GRADUATE SCHOOL OF SOCIAL SCIENCES ……. PROGRAMME MASTER/PHD THESIS TEZ BAŞLIĞI FULL NAME THESIS ADVISOR: ASST./ASSOC./PROF.DR. XXX YYY 20XX İZMİR. We certify that we have read this thesis and that in our opinion it is fully adequate, in scope and in quality, as a thesis for the degree of Master of Arts/the Doctor of Arts. Jury Members: Signature: Asst./Assoc./Prof.Dr. Xxx YYY … University Asst./Assoc./Prof.Dr. Xxx YYY … University Asst./Assoc./Prof.Dr. Xxx YYY … University Asst./Assoc./Prof.Dr. Xxx YYY … University Asst./Assoc./Prof.Dr. Xxx YYY … University Asst./Assoc./Prof.Dr. Xxx YYY … University .................... ....................... ..................... ..................... ..................... ..................... ----------------------------------------------------------------Asst./Assoc./Prof.Dr. Xxx YYY Director of the Graduate School ABSTRACT TEZ BAŞLIĞI First Name, Surname Msc/PHD, Name of the Programme Advisor: Asst./Assoc./Prof. Xxx YYY 20XX After the year 1990s, following the financial liberalization attempts, currency crises have been a common occurrence in developing countries. In the literature, both theoretical and empirical models were developed and economists have tried to explain the main reasons behind the crisis. Currency crises have contagion effects, thus predicting the variables which may lead to increase the possibility of financial crises are used in order to understand crises periods. The main purpose of this study, between the years 1987-2007, the currency crises occurred in 15 emerging countries, to assess which variables have explanatory power regarding the currency crisis with an unbalanced panel data analyze. In this paper, currency crisis (CCI) as a dependent variable is made as a weighted average of real exchange rate changes, international reserves changes and real interest rate changes and seven explanatory variables. The estimation results show that the leading indicators of currency crises are money supply growth rate (M2GROWTH), domestic credit provided by banking sector (BANKDC) and current account balance / reserves(CABTR). Thus, these results provide evidence in support of the thesis that currency crises are systematically related to the fundamental weaknesses in the real and financial sectors of the economy and parallel with the other empirical studies as well. Keywords: currency crises models, panel data analysis, theories of financial crises. ÖZ TEZ BAŞLIĞI Adı Soyadı Yüksek Lisans / Doktora Tezi, Program Adı Danışman: Yrd. Doç./Doç./Prof. Dr. Xxx YYY 20XX Gelişmekte olan ülkelerde finansal liberalleşme sürecini takiben özellikle 1990’lı yıllardan itibaren para krizleri sıkça görülen bir olgu haline gelmiştir. Söz konusu gelişmeler, literatürde para krizi modellerinin oluşmasına ve para krizlerinin tahminine yönelik yapılan ampirik çalışmaların artmasına olanak sağlamıştır. Bir ülkede yaşanan kriz diğer ülkelere de yayılabilmekte, bu nedenle krize sinyal teşkil edebilecek göstergelerin belirlenmesi, olası krizlerin engellenerek, maliyetlerinin azaltılması açısından önem arz etmektedir. Çalışmanın amacı, 1987-2007 döneminde 15 gelişmekte olan ülkede yaşanan para krizlerinin, hangi değişkenlerle açıklanabileceğinin panel veri analiziyle tahmin edilmesidir. Modelde reel döviz kuru, reel faiz oranı ve döviz rezervlerindeki yüzde değişimlerin standart sapmalarının oranına göre standartlaştırılmış değerlerinden oluşan “para krizi indexi” bağımlı değişken olarak alınmış olup, indexi açıklayıcı 7 bağımsız değişken belirlenmiştir. Analiz sonucunda, M2 para arzının büyüme oranı (M2GROWTH), cari işlemler dengesinin rezervlere oranı (CABTR) ve bankacılık sektörünün özel Sektöre açtığı kredi hacminin GSYİH’ye oranındaki yüzde değişme (BANKDC)’nin krize sinyal teşkil ederek, para krizi olasılığının arttırdığı sonucuna varılmıştır. Modelde elde edilen bulgular, bu ülkelerde görülen para krizlerinin I.nesil kriz modelleriyle açıklanabileceğini göstermektedir. Anahtar sözcükler: para krizi modelleri, panel veri analizi, finansal kriz teorileri. ACKNOWLEDGEMENTS I would like to thank my supervisor XXX for his guidance and patience during this study. Full Name İzmir, 20XX TEXT OF OATH I declare and honestly confirm that my study, titled “THESIS TITLE” and presented as a Master’s/PhD Thesis, has been written without applying to any assistance inconsistent with scientific ethics and traditions. I declare, to the best of my knowledge and belief, that all content and ideas drawn directly or indirectly from external sources are indicated in the text and listed in the list of references. Full Name Signature ……………………………….. July 28, 2017 TABLE OF CONTENT ABSTRACT ............................................................... Error! Bookmark not defined. ÖZ ............................................................................................................................... iii ACKNOWLEDGEMENT .......................................................................................... iv TEXT OF OATH ....................................................................................................... vii TABLE OF CONTENT .............................................................................................. ix LIST OF TABLES ...................................................................................................... xi LIST OF FIGURES .................................................................................................. xiii LIST OF ABBREVIATION ...................................................................................... xv INTRODUCTION ..................................................... Error! Bookmark not defined. 1. CHAPTER THEORIES OF FINANCIAL CRISIS………….…………………….5 1.1. The Core Characteristics of Financial Crises…………….……………..…..10 1.2. Keynes and Financial Crises..….………………………………………..….16 1.2.1. New Keynesian Theory: Asymmetric Information………………..…17 1.2.2. Post Keynesian Theory: Debt and Financial Instability Approach…..24 1.2.2.1. Fisher's Approach…………………… ……………..…..…..24 1.2.2.2. Minsky's Approach………………….……………..…..……25 1.2.2.3. Kindleberger's Approach……………………….…..…..…...27 1.3. Monetarism and Financial Crises...………………………………..………28 1.4. Random Withdrawal Risk………………………………………………....30 1.5. Theory of Speculative Bubbles……………………………………..….….30 2. CHAPTER CURRENCY CRISIS MODELS AND PREDICTING A CURRENCY CRISIS………………………………………………………………… 2.1. Characteristics of Currency Crises……… …………………………….….60 2.2. Currency Crisis Models...………………………….……………………....64 2.2.1. 1.Generation Models………………..…………………… ……..…..65 2.2.2. 2. Generation Models ………………………………………...…….68 2.2.3. 3. Generation Models………………......……………...……..……...70 2.3. Early Warning Systems: Signal Approach…………………………..…….72 2.3.1. Literature Review …………………………………………..….…...77 2.3.2. Data and Model……………………….………………………...…...81 CONCLUSION ......................................................................................................... 95 REFERENCES......................................................................................................... 100 APPENDIXES…………………………………………………………………......105 BRIEF CURRICULUM VITAE…………………………………………………..107 LIST OF TABLES Table 1. . .................................................................................. Error! Bookmark not defined. LIST OF FIGURES Figure 1… ................................................................................ Error! Bookmark not defined. LIST OF ABBREVIATIONS ADF : Augmented Dickey-Fuller. NBER : National Breau of Economic Research. NER : Nominal Exchange Rate. OECD : Organization of Economic Development and Corporation. OLS : Ordinary Least Square. PP-Fisher : Phillips-Peron Fisher. REM : Random Effect Model. Introduction Financial crises have exhibited a characteristic of a “twin crises”, banking crises with currency crises. Each currency crisis has differed in type from the preceding one but following sequences sharp depreciation of domestic currency followed by an abrupt recession, a loss of international reserves and a capital outflow always present. In the theoretical literature currency crises involve fixed Exchange rate regime or allowed currencies float within certain margins. Exchange rate crises are observed in economies which adapt fixed exchange rate regime as a result of abrupt speculative attacks of economic agents try to sell domestic currency for foreign currency until they expect that the government will not be able to defend fixed exchange rate. In response, monetary authorities are forced to defend the currency. If the authorities are no longer able to maintain the exchange rate, they decide to devalue the currency. Clearly, many reasons for expecting crises and due to a common cause, for instance policies may have similar effects on emerging countries. Thesis study is organized as follows. After the introduction, section one reviews the theoretical literature on financial crises, and section two discusses theoretical currency crisis models and the empirical literature on the determinants on currency crises. The data, methodology and estimation results of the models analyze in the same section, and the last part will conclude and bring some remarks. 2. CHAPTER CURRENCY CRISIS MODELS AND PREDICTING A CURRENCY CRISIS 2.3. Early Warning Systems: Signal Approach 2.3.1. Literature Review Economists focus on the timing and causes of the crisis and try to explain different experiences of countries by using models. Theoretical studies have identified mainly two theoretical models the traditional or first generation models (Krugman, 1979) and second-generation models (Obstfeld, 1986, 1994). These models can be dubbed as Latin type crises models based on the presence of inconsistent policies generates a speculative attack. Recent literature also concentrates on the predictability of currency crises by developing statistical methods like early warning systems (Kaminsky et al. 1998). Eichengreen, Rose and Wyplosz (1996) analyzed spillover effects among 20 countries during the period of 1959 and 1973, 77 crises. They built a currency crisis index constructed by changes in three variables international reserves, Exchange rate and interest rates. Findings are speculative attacks on fixed exchange rates play a significant role in currency crises. Krugman (1996) studied on 5 industrialized countries are affected by the ERM (1992-1993) crises by using annual, quarterly and also daily data over period 1988-1995. In this study four indicators, inflation, output gap, unemployment rate, public debt to GDP ratio are used and all these indicators support that ERM does not provide self-fulfilling crises. Corsetti, Pesenti and Roubini (1998) studied on 24 countries whose economic performances are affected by the 1997 Asia crisis. They construct a crisis index as a measure of speculative pressure on a country currency at first. Then they compute a set of indexes of financial fragility, external imbalances, official reserves adequacy and fundamental performance. The crisis index consists of exchange rate depreciation and foreign reserves. A negative sign of crisis index indicates more severe currency crisis. They found that weak cyclical performances, low foreign exchange reserves and financial deficiencies are the main reasons behind the Asian collapse. CONCLUSION In this study, i try to explain the causes of currency crises by using some crucial indicators. In order to analyze the currency crises we include the GDP growth, bank liquid reserves to bank assets ratio, domestic credit provided by banking sector, current account balance to reserves ratio, M2 growth, export growth to import growth ratio and portfolio investment to foreign direct investment ratio variables. These indicators are commonly used in signal approach, linear regression model and logit/probit models. Here, the unbalanced panel data estimation results show that the leading indicators of currency crises are M2 growth, domestic credit provided by banking sector and current account balance to reserves ratio. The results of empirical analysis provide evidence in support of the thesis that currency crises are systematically related to the fundamental weaknesses in the real and financial sectors of the economy. For example, the current account deficit is one of the main reasons of the weaknesses toward a possible currency crisis. Thus crises do not have self-fulfilling components. At the same time, empirical results are parallel with the other empirical studies as well. REFERENCES Akerlof, G. A. (2002). Behavioral macroeconomics and macroeconomic behavior. The American Economic Review, 92, 411-433. http://dx.doi.org/10.1257/00028280260136192 Beck, T. (2012). The Role of Finance in Economic Development – Benefits, Risks, and Politics, Dennis Müller (Ed.), Oxford Handbook of Capitalism. IMF (1998). Financial crises: characteristics and indicators of vulnerability. World Economic Outlook, 110-142. Kahraman, S. (2005). 1929-1939 İktisadi Devletçilik ve Sanayileşme Politikaları. (Unpublished MA Thesis). İstanbul Üniversitesi, SBE, İstanbul. Kaminsky, G., Lizondo, S. and Reinhart, M.C. (1998). Leading indicators of currency crises. IMF Papers, 45(1). Kindleberger, C. P. (2005). Manias, panics and crashes: A History of financial crises. John Wiley & Sons. Krugman, P. (1979). A model of balance of payment crises. Journal of Money, Credit and Banking, 11(3), 311-325. Krugman, P. (2002). Currency Crises. Retrieved from http://web.mit.edu/krugman/www/crises.html Levin, A., Chien-Fu, L. and Chia-Shang, C.(2002). Unit root test in panel data: Asymptotic and finite sample properties. Journal of Econometrics,108(1), 125. Minsky, H. P. (1992). The Financial Instability Hypothesis. The Jeroey Levy Economics Institute Working Paper74. Prepared for Handbook of Radical Political Economy. http://dx.doi.org/10.2139/ssrn.161024 Mishkin, F. S. (2006). The Economics of Money, Banking, and Financial Markets. 7edt, Pearson-Wellesley. Mishkin, F. S. (2001). Financial Policies and the Prevention of Financial Crises in Emerging Market Economies. NBER Working Paper 8087. Mishkin, F.S. (1996). Understanding financial crises:A Developing country perspective. NBER Working Paper 5600. Obstfeld, M. (1996). Models of Currency Crises with Self-fulfilling Feature. European Economic Review, 40(1), 1037-1047.