CURRENCY MISMATCHES IN EMERGING MARKETS: CAUSES AND IMPLICATIONS FOR FIRMS' INVESTMENT DURING CURRENCY CRISES

Abstract

This thesis studies two related issues that have gained relevance as a consequence of several of the major currency crises of the 1990s. The first is the impact that devaluations have on investment when domestic firms have currency mismatches, i.e., debt denominated in foreign currency and assets and revenues in domestic currency. The second has to do with the causes behind the widespread presence of currency mismatches in many economies of the world.

Chapter 2 analyzes the first issue using firm level data for Thailand to test for the impact of currency mismatches on firms' investment during the Asian crisis. A key feature of the analysis is that it exploits the heterogeneity that exists in the degree of currency mismatch across firms in order to identify the mentioned impact.The results of this chapter suggest that currency mismatches played a statistically significant role in explaining the investment decline observed in Thailand during and after the Asian crisis, and, as a result, that a balance sheet channel may have operated during the crisis. The results also suggest that omitting complementary explanations of the Asian crisis, in particular the presence of over-investment prior to the crisis, produces an artificially high impact of currency mismatches on investment. This result occurs due to the co-movement that investment and currency mismatches have in the period preceding the crisis.

Chapter 3 assesses the generality of the results of the previous chapter by analyzing other three countries that were involved in the Asian crisis: Indonesia, Malaysia, and South Korea. Although less robust due to data limitations, the analysis is still very insightful.

Chapter 4 deals with the second issue mentioned in the first paragraph. The chapter proposes a model that emphasizes the incentives of domestic governments to generate opportunistic devaluations in order to transfer resources from foreign lenders to domestic borrowers in case debt contracts were denominated in domestic currency. The model is not only able to explain why firms end up having currency mismatches, but it is also consistent with several of the stylized facts associated with international capital movements.