On the Role of Mutual Funds During Crises

Research and Event Summaries

Project Abstract

A myriad of currency crises has plagued the last decade of the 20th century. These crises have not been confined to national borders, nor have they been confined to a region. The Thai crisis engulfed-within days-Malaysia, Indonesia, and the Philippines. The Russian crisis spread as fast to countries as far apart as Brazil and Pakistan. Even developed countries have been affected, with the Russian default and devaluation reverberating in financial markets in the United States, Germany, and Great Britain.

Naturally, these events have triggered a hot debate about the seemingly contagious nature of crises. Much of the debate centers on the role of financial inks, leading to an explosion of theoretical work on topics like investor herding behavior, and the role of cross-market hedging or asymmetric information in propagating crises. Still, empirical evidence on the role of financial links is skimpy at best. Most of the evidence concentrates on the behavior of prices, be it stock market prices, exchange rates, or interest rates. In particular, the focus has been on price comovements, and whether comovement differs across tranquil and crisis times. To better understand the crisis of the 1990s, some authors have concentrated on the behavior of investors. For example, following the attack of Malaysia's Prime Minister on "rogue international speculators" in September 1997, come studies examined whether foreign investors contribute to financial-market instability. But these studies cannot clarify the possibly contagious effects of investors' behavior because they examine the evolution of investors' portfolios in only a single country. This contagious effect on investors' behavior was brought into the spotlight in (witness Malaysia, 1998), who focus on the role of international banks in the propagation of the currency crisis in Latin America during the early 1980's, and even in Asia during 1997. But banks are only one kind of international investor, and as of late not even the most important one. The growth of portfolio flows to about 45 percent of total private flows to emerging economies in the early 1990's points to the need for understanding the role of other investors, such as mutual funds, pension funds, and hedge funds. This study will examine the behavior of mutual funds specializing in emerging markets.

Faculty

Graciela L. Kaminsky (PI), Professor, Department of Economics

Events

Globalization and Risk in the International Financial System
Globalization Brown Bag, February 2003

Publications

Managers, Investors, and Crises: Mutual Fund Strategies in Emerging Markets
Occasional Paper, CSGOP-02-07

Economic Fragility, Liquidity, and Risk: The Behavior of Mutual Funds During Crises
Occasional Paper, CSGOP-03-21

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