Contents :
A currency crisis, defined as a sharp decrease in the nominalvalue of the currency, could have a significant impact on the economy in termsof contraction of output, increase in unemployment and even collapse of banks.Over the last three decades, the frequency of currency crises has increased; butit is the increase in their magnitude, particularly that of the East Asiancrisis of 1997, that is most significant.
The increase in the number of these crises and the importance oftheir impact of the economy has generated a large amount of research into theircauses. At the theoretical level, the literature distinguishes between two maintypes of models of currency crises. The first, which was prevalent over the1980s, identifies weaknesses in economic fundamentals as the causes of thecrisis and the persistence of these weaknesses makes maintenance of the peggedexchange rate regime unsustainable and thus the crisis inevitable. The secondtype of models was motivated by the Exchange Rate Mechanism (ERM) of theEuropean Monetary System (EMS) crisis of 1992-93 in which a speculative attackon some currencies resulted in a widening of the band despite the fact thatbased on fundamentals the pegs were sustainable. This type of models focuses onthe self-fulfilling features of currency crises and its major implication isthat these crises are very hard to predict.
Based on theoretical priors, a number of modelshave been developed and applied for the purpose of predicting currency crises.The idea is that if a model that could predict a currency crisis with somedegree of accuracy were available, then policymakers could take the necessaryactions to avoid the crisis or at least minimize its impact. A few models haveclaimed success based on in-sample prediction, but have failed when applied forout-of-sample prediction.
The purpose of the present paper is to discuss the issues mentioned above andthen apply the main currency crises indicators identified in the literature tothe case of Arab countries. Section 2 reviews the main theories of currencycrises. Section 3 analyzes three of the most cited models as having providedsome conclusive results regarding predictability of currency crises. Based onthe discussion in the previous two sections, section 4 focuses on a group ofArab countries that officially adopt a pegged exchange rate regime. Theobjective of the exercise is to detect any potential vulnerability of thesecountries to currency crises. Section 5 concludes.