Causes of the Asian Financial Crisis – Weak Fundamentals or Investor Panic?
Causes of Asian Financial Crisis Dissertation – This paper seeks to identify the primary cause of the Asian Financial Crisis in each of the 6 Asian economies that are covered, taking into account the unique circumstances in each country. This will be done by logistic regression, providing empirical evidence to discriminate between the two hypotheses: Weak Fundamentals or Investors’ Panic.
Real exchange rate, international reserves, money supply and GDP are selected over many other variables as the leading variables of the model. The results show that in Indonesia, Korea and Thailand, weak fundamentals were the key cause of the Asian Financial Crisis, whereas Malaysia, Philippines and Singapore suffered due to investors’ panic. Critique of the model is anticipated and then, addressed. This study shall then recommend policy reforms for each country, differing, according to the situation in each economy.
As can be imagined, an event on such a scale has been scrutinised by many around the world. Consequently, much research has been conducted as to why the crisis occurred. Exactly 10 years on, a final synthesis is unavailable as yet, a consensus no where in sight, with academia still studying and arguing over the event, with many reasons implicated as the culprit. Since then, two main views have emerged; with the first citing weak fundamentals as the primary cause of the crisis and the second postulating investors’ panic, regional contagion to have caused the Asian Financial Crisis.
There was sufficient proof of investor panic in the region, but whether it was warranted or uncalled for, it is unknown, as there was also clear evidence that some Asian economies were frail. Some arguing on the weak fundamentals front has countered that without weaknesses in the economy, why would investors panic? However, we must keep in mind of two possibilities overshadowing such a simple question. Firstly, investors could be irrational. Overreaction by investors is fairly common.
With a slight shock, to an otherwise relatively healthy economy, might sometimes be sufficient to topple the financial system. Although the information flow today is much smoother, with greater transparency in dealings, even with superior information, it does not guarantee superior decision making. There is also the consideration that although investors might be rational, their motives are individually selfish. This brings us to self-fulfilling runs. In the case of the Asian Financial Crisis, there was the Korean chaebols (corporate conglomerates) and Thai financial institutions that first collapsed, which brought about large investors to getting out of harms’ way, in fear of the economy collapsing.
This then induced other investors to anticipate other investors pulling out. This prediction led them to be individually rational and so pulled out of the economy. This self-fulfilling run can be easily explained with game theory, the classic prisoner’s dilemma.
- 14,000 words – 55 pages in length
- Excellent use of literature
- Expertly written throughout
- Good in depth analysis
- Ideal for finance and business students
2. Literature Review
Select Independent Variables
Current Account: Real Exchange Rate
Capital Account: International Reserves
Financial Sector: Money Supply
Fiscal Sector: GDP
6. Policy Reforms