Currency crises theory : third generation models

Abstract

This thesis investigates third generation currency crisis literature and concludes that the 2001 Turkish currency crisis can be labeled as a third generation type crisis, despite having unique characteristics. According to the model of Eijffinger and Goderis (2007) which derives risk premium of the economy from the balance sheet structure of the corporate sector, higher domestic debt increases the probability of currency crisis, whereas higher foreign debt can either increase or decrease the probability of a currency crisis depending on the parameter values. This model has little explanatory power for the 2001 crisis, since the crisis predominantly arise from the maturity mismatch problem in the balance sheet of the financial sector, coupled with moral hazard problem driven by implicit government guarantees. In addition to these two issues which are examined by different strands of third generation currency crisis literature, Turkish crisis display distinctive characteristics such as the role of fragile fiscal deficit financing mechanism.