Working Paper: CEPR ID: DP10058
Authors: Luis A. V. Catao; Gian Maria Milesi-Ferretti
Abstract: We examine the determinants of external crises, focusing on the role of foreign liabilities and their composition. Using a variety of statistical tools and comprehensive data spanning 1970-2011, we find that the ratio of net foreign liabilities to GDP is a significant crisis predictor. This is primarily due to the net position in debt instruments--the effect of net equity liabilities is weaker and net FDI liabilities seem if anything an offset factor. We also find that: i) breaking down net external debt into its gross asset and liability counterparts does not add significant explanatory power to crisis prediction; ii) the current account is a powerful predictor; iii) foreign exchange reserves reduce the likelihood of crisis more than other foreign asset holdings; iv) a parsimonious probit containing those and a handful of other variables has good predictive performance in- and out-of-sample. The latter result stems largely from our focus on external crises sensu stricto.
Keywords: currency crises; current account imbalances; foreign exchange reserves; international investment positions; sovereign debt
JEL Codes: E44; F32; F34; G15; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher net foreign liabilities (NFL) (F65) | Increased risk of external crises (F65) |
| NFL exceeding 50% of GDP (Z21) | Increased risk of external crises (F65) |
| Net debt liabilities (H63) | Increased risk of external crises (F65) |
| Net portfolio equity or foreign direct investment (FDI) liabilities (F21) | Weaker or offsetting effects on crisis risk (F65) |
| Current account deficits (F32) | Higher risk of external crises (F65) |
| Foreign exchange reserves (F31) | Reduced likelihood of crises (H12) |