Exchange rates and sovereign risk

Date

2024-3

Author

Sağlamdemir, Tuğba

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In recent decades, economic crises have hit Asia in the „90s, Latin America in the 2000s, and global finance in 2007, which signals the importance of analyzing the crisis. In this study, in order to study the crisis and its determinants, we first analyze the occurrence rate of banking, systematic, currency, inflation, domestic debt in default and sovereign external debt crises observed between 1800 and 2016 by classifying 64 countries into financial centers, non-financial centers, developed countries, developing countries, emerging market countries. The period under scrutiny is subdivided into the First World War (1914-1918), the Great Depression (1929), the Second World War (1939-1945), the First Oil Crisis (1973), the Second Oil Crisis (1979) and the Great Recession (2008), and the impact of these events on the occurrence rate of crises is investigated. The First World War increased the incidence of currency crises, the Great Depression increased the incidence of external debt crises, the First Oil Crisis increased the incidence of currency crises, and the Second Oil Crisis increased the incidence of banking crises. The results of the analysis of crises for country groups show that sovereign debt crisis has the highest incidence rate. This result leads the study on sovereign debt crisis to consider sovereign default as a precursor to sovereign debt crisis and to analyze sovereign default with sovereign risk. In this study, credit default swap is applied as a method of measuring sovereign risk. The questions that the analysis aims to answer are the effect of exchange rate on sovereign risk for all country groups and emerging market economies. Subsequently, we plan to investigate the potential reverse causality that may arise in this relationship. We will then investigate the impact of exchange rate regime and capital openness on this relationship. We investigate the impact of exchange rate effects by applying the fixed effect panel data model for both all country groups and the emerging market economies country group. According to the results of the analysis, we report that the exchange rate has a statistically significant effect on the credit default spread for both sets of countries and exchange rate volatility has a statistically significant effect on the credit default spread for emerging market economies. We apply a two-stage system GMM procedure taking into account potential reverse causality and find that the panel system GMM results are broadly similar to the results from a panel fixed effects approach. Exchange rate regime is reported to be a determinant factor for both sets of countries, with the highest marginal contribution of exchange rate and exchange rate volatility obtained in the flexible exchange rate regime, especially for emerging market economies. Moreover, capital openness is a factor that affects the marginal impact of both the exchange rate factor and the marginal impact of domestic and international factors, and it is estimated that the highest marginal impact of the exchange rate and exchange rate volatility affect credit default swaps, especially for high capital openness country groups.

Subject Keywords

Financial crisis, Sovereign debt, Foreign exchange, Crisis management, Panel data models

URI

https://hdl.handle.net/11511/109147

Collections

Graduate School of Social Sciences, Thesis