Covered Interest Arbitrage and the Currency Crisis in Korea

In-June Kim () and Jung Seok Woo ()

Working Paper Series from Institute of Economic Research, Seoul National University

Abstract: This article closely examines the maintenance of the covered interest parity during the course of the currency crisis in Korea, and analyzes the movement of the covered interest differential(CID) in an effort to draw out some policy implications. This article also takes a thorough study of whether a self-fulfilling expectation has actually been a triggering cause for the crisis in Korea. During the course of the currency crisis in Korea, it seems that a substantial discrepancy of CID has been persistent for a considerable period of time. This phenomenon can be attributed to the following two factors: expectations for a devaluation and the risks regarding a sovereign bankruptcy. This article also analyzes the relationship between CID and capital flows, and elicits some evaluations on the high interest rate policy implemented throughout the IMF supported program. In the course of the Korean currency crisis, most of the capital outflows took place in the areas of portfolio investment and bank loans, with the ratio of outflow of the latter outweighing that of the former. The policy objective of the high interest rate policy was to prevent capital outflows by improving the rates of return at home. Nevertheless, this attempt proved futile, or at most limited, since it could not provide any explicit policy channels to prevent the refusal of credit rollover. Moreover, it failed to prevent further capital outflows in portfolio investment, since it could not offset the risks of sovereign default.

New Economics Papers: this item is included in nep-ifn and nep-mon
Date: 1999-08

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