Augustine H. H. Tan

Markov Chains in Predictive Models of Currency Crises: With Applications to Southeast Asia

A Markov regime switching model for exchange rate fluctuations, with time-varying transition probabilities, is used in constructing a monthly model for predicting currency crises in Southeast Asia. The approach is designed to avoid the estimation inconsistency that might arise from misclassification errors in the construction of crisis dummy variables which other approaches (such as probit/logit and signaling) require. Our methodology also addresses the serial correlations and sudden behavior inherent in crisis occurrence, identifies a set of reliable and observable indicators of impending crisis difficulties, delivers forecast probabilities of future crises over multi-period forecasting horizons, and offers an empirical framework for analyzing contagion effects of a crisis. Our empirical results indicate that the Markov switching model is moderately successful at predicting crisis episodes, but also points to future research in various directions. Most early warning systems for currency crises have used either probit or signaling. Several issues can be raised regarding these techniques: the need for a priori dating of crisis occurrence, the use of arbitrary thresholds, inadequate modeling of the dynamics in the system, among others. We present an alternative framework, based on a Markov-switching model of exchange rate fluctuations with time-varying transition probabilities, which addresses these concerns.

Monetary Policy Cooperation to Support Asian Economic Integration

This paper considers the form of monetary policy coordination and regional exchange rate arrangement that would best support economic and financial integration in East Asia. In view of the regions economic diversity, we propose a graduated program of informal policy cooperation from weak forms of cooperation to more intensive modes of cooperation such as the adoption of common monetary policy objectives. An array of informal monetary arrangements rooted to the degree of institutional development can improve the effectiveness of both sovereign and regional institutions, and promote integration in East Asia. Drawing upon the European experience with the Exchange Rate Mechanism (ERM), we conclude that East Asia should first embark on other forms of integration to aid in the development of a high degree of real and nominal convergence amongst the regional countries. Only then would an ERM-type system that employs a regional monetary unit become more sustainable and less susceptible to speculative currency attacks in the region.

Underpriced Default Spread Exacerbates Market Crashes

In this paper, we develop a specific observable symptom of a banking system that underprices the default spread in non-recourse asset-backed lending. Using three different data sets for 18 countries and property types, we find that, following a negative demand shock, the underpricing economies experience far deeper asset market crashes than economies in which the put option is correctly priced. Furthermore, only one of the countries in our sample continues to exhibit the underpricing symptom following a market crash. This indicates that market crashes have a cleansing effect and eliminate underpricing at least for a period of time. This makes investing in such markets safer following a negative demand shock.

Singapore's Economy: Growth and Structural Change

Evolution of Singapores Economy Singapore has always thrived on international trade and in the past had adjusted to the vicissitudes of the global economy chiefly by the instrument of migration. Boom times attracted immigrants. Correspondingly, severe recessions saw emigration back to the respective countries of origin. During the Great Depression of the 1930s for example, substantial emigration took place and this helped the colony to survive the period. In late 1959, the colony achieved self-government and the present Peoples Action Party (PAP) government, led by Mr Lee Kuan Yew, came to power. The immediate and critical task was to create jobs. With a high population growth (3.2 per cent) and a 0.7 per cent net annual immigration, unemployment was serious at 13.5 per cent. It was estimated by the United Nations Industrial Survey Mission that 214,000 jobs would need to be created in the decade of the sixties. This represented nearly 48 per cent of the total employment in 1960 (Table 1). Of the new jobs to be created, 98,000 would have to be found in manufacturing. The task seemed daunting. The economy was stagnating at 0 per cent GDP (gross domestic product) growth and manufacturing employment then totalled 27,000, or 7.5 per cent of total employment. The economy depended heavily on entrep?t trade: direct entrep?t earnings amounted to 18 per cent of GDP. Indirectly, there was also dependence on finance, transport, communications and manufacturing (processing). By 1960, most countries in the region were increasingly trading direcdy with the industrialized countries and had begun to process their own raw materials as well as to develop simple manufactures. The newly-elected government in Singapore saw its main task as the creation of a sizeable manufacturing sector to be the new engine of growth. Four disadvantages were identified: the free port status, which was deemed to be disadvantageous to industrialization; lack of free access to the market of the then Federation of Malaya; inadequate numbers of technical personnel, managerial staff, foremen and skilled workers; and the trading, speculative mentality of entrepreneurs. However, against these disadvantages, the ruling party recognized four positive factors: a hardworking, resourceful and enterprising, largely immigrant people; a strategic geographical position and excellent sea communications; a substantial amount of capital accumulated by local firms and public authorities; and potential markets in the region. In terms of markets, the key target at that stage was the Federation of Malaya. Politically, therefore, the government worked hard to achieve merger in a larger Federation of Malaysia in order to create viability and a larger market. In terms of industrial policy, the government had a multi-pronged strategy: