The Investment Cost of Currency Crises in Emerging Markets: An Empirical Treatment from 1994-2015

Abstract

Currency crises – large and sudden depreciations in the value of a country’s currency – have been an unfortunate by-product of increased financial openness over the last half century. This study extends the already vast literature on the impact of currency crises by estimating how currency crises affect domestic investment in emerging markets. Specifically, the study uses panel data with fixed effects and various robust standard errors as well as a generalized method of moments estimator to investigate the impact of currency crises on domestic investment in a sample of 14 countries that experienced currency crises between 1994 and 2015 and 10 that did not. The results of the analysis initially indicate that, after controlling for a host of macroeconomic fundamentals, currency crises contribute significantly to dampened domestic investment. Ultimately, after controlling for banking crises, the study concludes that relatively severe, but not all, currency crises have a significant depressing effect on investment. The results further indicate that all currency crises should not be treated equally; those involving exceptionally large depreciations lead to an even greater decline in domestic investment.