The 1997 financial crisis in Asia and self-fulfilling prophecy

Abstract

The financial crisis in Asia was set off in Thailand in 1997 and escalated into financial turbulence at global level very quickly. How did this happen? Was it a matter of self-fulfilling prophecy or the deterioration of fundamentals? This study is an attempt to explore whether the financial crisis in Asia that started in 1997 was a self-fulfilling prophecy or was due to the deterioration of fundamentals. The theory proposed by Jeanne (1997) was adopted and the two-state Markov regime-switching model was applied to test the hypothesis in this study. The empirical findings of this study led us to understand that there were at least two forms of equilibrium, among other forms of equilibrium, which existed in the different countries of Asia before the outbreak of the financial crisis. In Thailand, Philippines and South Korea, the effect of a self-fulfilling prophecy indeed existed, which indicated that self-fulfilling prophecy did play an indispensable role in the financial crisis. Similarly, the two-state Markov regime-switching model performed better than other traditional linear models and was able to help to map out the probability of currency depreciation. The timing under this model approximated the timing of the outbreak of the crisis as well. Therefore, this model is viable as a tool for future study of financial crises.