Financial stress and its non-linear impact on CEE exchange rates

0496144 - NHU-C 2019 RIV US eng J - Journal Article
Adam, T. - Benecká, S. - Matějů, Jakub
Financial stress and its non-linear impact on CEE exchange rates.
Journal of Financial Stability. Roč. 36, June (2018), s. 346-360. ISSN 1572-3089. E-ISSN 1878-0962
Institutional support: Progres-Q24
Keywords : asset allocation * exchange rates * financial stress
OECD category: Applied Economics, Econometrics
Impact factor: 2.301, year: 2018

This paper studies the reaction of selected CEE (satellite) currencies to increased financial stress in the euro area (core) and also in global financial markets. We suggest that this reaction might be non-linear, the “safe haven” status of a satellite currency may hold in calm periods, but breaks down when risk aversion is elevated. A stylized model of portfolio allocation between assets denominated in euro and the satellite currency suggests the presence of two regimes characterized by different reactions of the exchange rate to an increased stress in the euro area. In the “diversification” regime, the satellite currency appreciates in reaction to an increase in the expected variance of EUR assets, while in the “flight to safety” regime, the satellite currency depreciates in response to increased expected volatility. We suggest that the switch between regimes is related to changes in risk aversion, driven by the level of strains in the financial system as captured by financial stress indicators. Using the Bayesian Markov-switching VAR model, the presence of these regimes is identified in the case of the Czech koruna, the Hungarian forint and the Polish zloty.
Permanent Link: http://hdl.handle.net/11104/0288958