An eclectic approach to currency crises: drawing lessons from the EMS experience

This article examines the regime changes in the European Exchange Rate Mechanism (ERM), by applying the duration model approach to quarterly data of eight currencies participating in the ERM, covering the complete European Monetary System history. We first make use of the nonparametric (univariate) analysis, finding that the probability of maintaining the current regime decreases very rapidly for the short durations to register then smoother variations as time increases. Second, we apply a parametric (multivariate) analysis to investigate the role of other variables in the probability of a regime change. In particular we consider three alternative theoretical frameworks to select potential explanatory variables: first- and second-generation models of currency crisis and an eclectic model that combines the explanatory variables suggested by both models. Our results suggest that the Weibull specification of the eclectic model would be the more appropriate to fit our data set, finding that the real exchange rate, the interest differentials and the central parity deviation would have negatively affected the duration of a given regime, while credibility, the level of international reserves and the price level in the anchor country would have positively influenced such duration. Finally, we do not find evidence of observed heterogeneity associated to currencies with different behaviour in the sample, nor the existence in our sample of unobserved heterogeneity caused either by misspecification or omitted covariates.