Currency Crash and Speculative Currency Investment under Flexible Exchange Rates

Abstract

This study documents substantial disparity in currency volatility and crash incidents between emerging markets and industrialized countries. Under the same flexible exchange rate regime, currencies in emerging markets are more volatile and experience more crashes. The paper investigates whether international financial investments attracted to higher interest rate in emerging markets contribute to the disparity. Using Vector Autoregression (VAR) models and data from 23 countries, the study confirms that the relative higher interest rate accounts for a large part of the more volatilities and crashes in currencies of emerging countries. The results imply that emerging economies may not necessarily benefit from a flexible exchange rate regime, which was thought to be a shock absorber that could avert large crashes in currency.