Fundamentals and joint currency crises

Philipp Hartmann, Stefan Straetmans () and Casper G. de Vries ()
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Stefan Straetmans: University of Maastricht - Limburg Institute of Financial Economics (LIFE), Faculty of Economics - Finance Department, P.O. Box 616, NL-6200 MD Maastricht, Netherlands, http://www.fdewb.unimaas.nl/finance/?page=news

No 324, Working Paper Series from European Central Bank

Abstract: In this note we demonstrate that in affine models for bilateral exchange rates, the nature of return interdependence during crises depends on the tail properties of the fundamentals' distributions. We denote crisis linkages as either strong or weak, in the sense that the dependence remains or vanishes asymptotically. We show that if one currency return reaches crisis levels, the probability that the other currency breaks down as well vanishes asymptotically if the fundamentals' distributions exhibit light tails (like e. g. the normal). However, if the marginal distributions exhibit heavy tails, the probability that the other currency breaks down as well remains strictly positive even in the limit. This result implies that linearity and heavy tails are sufficient conditions for joint or contagious currency crises to happen systematically through fundamentals.

Keywords: Financial Crises; Currency market linkages; Fundamentals; Heavy Tails; Asymptotoc Dependence (search for similar items in EconPapers)
JEL-codes: G12 F31 G39 C49 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-ifn
Date: 2004-03
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Related works:
Working Paper: Fundamentals and Joint Currency Crises (2004)
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