Evaluating Capital Account Liberalization and Exchange Rate Regimes : An Empirical Study by Controlling for the Endogeneity of Policy Selection

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This study evaluates the effect of de facto exchange rate regimes on the occurrence of currency crises. To estimate the effect of exchange rate regimes properly, we must control the simultaneous problem, the problem of reverse causality, and the self-selection problem of regime adoption. However, previous studies do not explicitly address these problems. To address these problems, we employ a variety of microeconometric methods and examine the effect of de facto exchange rate regimes on the occurrence of currency crises and the effect of exchange rate regimes under restricted or liberalized capital flows on the incidence of currency crises. We find that pegged regimes significantly decrease the likelihood of currency crises compared with floating regimes. We also find interesting evidence that pegged regimes with capital account liberalization significantly lower the likelihood of currency crises compared with other regimes. These results are robust to a wide variety of econometric methods and samples.