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Exchange market pressure: some caveats in empirical applications

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Abstract:

The Exchange Market Pressure (EMP) index, developed by Eichengreen et al. (1994), is widely used as a tool to signal whether pressure on a currency is softened or warded off through monetary authorities' interventions or, rather, a currency crisis has originated. In this article we show how the index is sensitive to some assumptions behind the aggregation of the information available (exchange rates, interest rates and reserves), especially when emerging countries are involved. Specifically, we address the way exchange rate variations are computed and the impact of different definitions of the reserves, and we question the constancy of the weights adopted. These issues compound with the choice of a fixed threshold when crisis episodes are identified through the EMP index. As a result, one should exert caution in subsequent econometric analyses where a dependent binary variable is built to identify crisis periods.

Document Type: Research Article

DOI: https://doi.org/10.1080/00036840701858059

Affiliations: 1: Dipartimento di Scienze Economiche, Universita degli Studi di Firenze, 50127 Firenze, Italy 2: Dipartimento di Statistica 'Giuseppe Parenti', Universita degli Studi di Firenze, 50134 Firenze, Italy

Publication date: 2010-08-01

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