REGIONAL CO-MOVEMENT IN FOREIGN EXCHANGE RATES

Abstract

Currencies of Asian countries are known to move together due to the fact that central banks of a number of these countries typically manage their exchange rates by pegging to a trade­ weighted basket of currencies.

The interdependence of these various currencies is highlighted when the Asian financial crisis hit the region. Devaluation of the Thai baht led very quickly to the downslide of the Malaysian ringgit, Indonesian rupiah, and South Korean won.

This thesis attempts to make use of the concept of cointegration to test for the presence of long run equilibrium relationship among the Singapore dollar, Japanese yen, South Korean won, Malaysian ringgit, and Thai baht in both pre crisis and crisis periods. In addition, it uses a Vector Error Correction Model to capture the dynamics of these exchange rates. Following which, the transmission of innovations between these currencies are examined by looking at the various residual correlation coefficient matrices, impulse response functions, and variance decompositions for both pre crisis and crisis periods. Through the above exercise, a better understanding of the state of relationship that existed among the currencies before the crisis, and the impact of the crisis on regional currencies' co-movement is obtained.