erc/metu
INTERNATIONAL CONFERENCE IN ECONOMICS  IV
September 13-16, 2000, Ankara

Pragmatic Response to Devaluation

M. R. Safarzadeh (California State Polytechnic University, USA)
Hosein Piranfar (Schiller International University, UK)

Abstract  

Financial crises and competitive devaluations in particular in developing countries frighten investors off and shatter the hopes and aspirations of economic development giving rise to further irrational behaviour and herd mentality. Firms and Governments are mutually mystified about each others next move. Uncertainty is very high. To respond to this situation we have looked at the history of devaluation (25 years) both before and after the incidence in many countries so that we can provide investors with an alternative for panic. It is hoped that it may dispel the shroud of irrational agitation rooted in lack of information and hasty judgements based on fear and uncertainty. As a first step we compare the pre- and post-devaluation returns to investment. With opposite signs the picture is clear, with identical signs, however, we examine the situation further involving the behaviour of the currency. Treating devaluation as a shock to market we use intervention function analysis running the best fitting ARIMA on the variable under study for the longest span of data before or after intervention. The data covers the post Bretton Woods era of 1973:03-1998:01, obtained from Global Financial Database, but the statistical tests are conducted for the 1974:01-1998:01 time period to avoid non-stationarity caused by the "new" data-generating process. Also, to avoid serial correlation resulting from temporal aggregation, this study uses the end of the month spot dollar prices of foreign currencies. All the exchange rate and stock return data were tested for the presence of a unit root in the individual series. We are well aware of the dangers of grouping diverse countries together; we are also cognizant of difficulties involved in 'learning' from history. Nonetheless any attempt to ward off irrational fear of investment in developing countries by means of presenting a well-rounded quantitative analysis is, hopefully, worth the effort.

Economic Research Center
Middle East Technical University
06531 Ankara Turkey
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e-mail: metuerc@metu.edu.tr