Emerging Market Carry Trades and Financial Crises

This chapter book identifies three crisis warning indicators driven from trading in emerging markets' carry trades, and empirically examines whether these indicators could predict two major financial crises that hit the global financial markets in the last decades – The 1997-1998 Asian crisis and the 2007-2008 global crisis. The Probit regression is used to examine the power of the three indicators in forecasting financial crises, using data from eight Asian emerging countries which serve as proxies for emerging markets, independent of the origination of the crisis. I use both fixed effect and random effect estimation to measure crisis impacts.The empirical results show that financial crises could have been predicted. Probit estimation show that carry trade returns can predict a financial crisis, and the estimation results are robust to both panel level and country-level analysis