Contagion effects, informational effects, and economic fundamentals: an analysis of exchange rate dynamics during the Asian currency crisis

Abstract

This paper empirically analyzes the relative importance of economic fundamentals and contagion effects in driving the exchange rate dynamics of nine East Asian economies in the 1990's. Our results show that while changes in the exchange rate in each economy responded to a unique set of macroeconomic variables, a strong interrelationship between exchange rate changes was also present. After the onset of the Asian currency crisis, the correlation between exchange rate movements had increased, notably between economies of similar macroeconomic structure. However, economic fundamentals remained exerting a significant effect in driving exchange rate changes throughout the whole sampling period, and their influence strengthened in the post-crisis period This "structural break" suggests informational effects -- the collapse of one currency provides economic agents with information to reassess the economic fundamentals Our findings thus reject the hypothesis of unwarranted contagion. And if the Asian currency crisis was contagious at all, it would be warranted and justified by economic fundamentals -- spreading from one country to another with similar macroeconomic structure and policies.