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What we know, what we still need to know: the Asian currency crisis revisited

Authors

  • Ismail Ait-Saadi,

    1. School of Business & Design, Swinburne University of Technology, Sarawak Campus, Malaysia
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  • Mansor Jusoh

    1. Faculty of Economics & Business, University Kebangsaan Malaysia (UKM), Malaysia
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    • Ismail Ait-Saadi, Senior Lecturer, School of Business & Design, Swinburne University of Technology, Sarawak Campus, Malaysia; and Mansor Jusoh, Professor, Faculty of Economics & Business, University Kebangsaan Malaysia (UKM), Malaysia.


Abstract

From the literature on currency crises, it is widely understood that weak economic fundamentals increase tremendously the probability of currency crises, especially in emerging markets. However, what was not known is that an accumulation of small problems interacting with each other can be equally damaging. Using a new technique, a combination of Classification and Regression Tree (CART) and Logit regression, this paper re-examines the causes of the Asian currency crisis in 1997–98. The results indicate that although weak fundamentals were at the root of the crisis, only self-fulfilling panic and herd behaviour can explain the severity of the crisis. Contrary to previous empirical research, our results indicate that the Asian crisis was caused by the accumulation of small fragilities rather than large deficiencies in the macroeconomic fundamentals. An important policy implication of such findings is the need for governments not to underestimate small problems, which, when they interact, can create chaos. Another novelty of this paper is the interpretation of the crisis in terms of the concepts of trigger and vulnerability, using an empirical model that captures the magnitude of the self-fulfilling panic and its contribution to capital reversal and eventually to the collapse of the currencies.

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