Global Foreign Exchange Market: A Crisis Analysis

Abstract

The global financial market is often taken as an inherently fragile system that is prone to irrational exuberance, unfound pessimism and crises. Faced with such a system, researchers and analysts often seek to explore the roots of crises and the channels through which they reverberate from the center to periphery. While financial disasters are probable it would be nice if they are predictable. The investors, analysts and the policy-makers would sit comfortably if stress or crisis in one financial market could be predicted from those in other markets. This is particularly the area where the present study intervenes with a focus on the foreign exchange market. It considers three exchange rates defined between (i) two emerging nations (India and Singapore), (ii) an emerging and a developed nation (India and the US) and (iii) two developed nations (the US and the UK). In terms of stress indexes defined for each of these markets, it found no causality between stock market and foreign exchange market stresses for the developed-developed market pair. For the emerging markets, particularly for India, such channels of stress transmission remain and foreign exchange market crisis and stock market crisis (whether generated domestically or emanating from the developed, foreign market) may appear as “twin”. For Singapore, however, such a channel exists where stress is generated only in the other emerging market. Thus, the emerging markets that experience huge inflow of foreign capital in their stock markets might take stock market crises and foreign exchange market crises as twin. The policy implications, however, might differ. In some cases, it would be enough to regulate the domestic stock market, but in some other instances crises may be contagious coming from stock markets abroad.