The 1998 Russian crisis : could the exchange rate volatility have predicted it?

Abstract

The purpose of this paper is to examine the exchange rate volatility of the ruble, before the August 1998 crisis, using a macro-economic model of the Russian Federation developed by Basdevant (2000). A main focus of this paper is to use this simulation exercise to find out what was the origin of this financial crisis. This paper will show how expectations of the exchange rate played a crucial role. Nevertheless, this analysis does not seek to only explain the Russian crisis by a specific shock on expectations the objective is also to provide an analysis of the timing of the crisis. A further objective is to demonstrate a new methodology that allows an econometric model to be used to forecast the possibility of financial crises.

Finally this paper demonstrates that a model can be used to assess the likelihood of an unusual event such as the Russian financial crisis by exploiting the information, which is contained in the model’s own residual process. Using this technique we demonstrate that the variance of exchange rates produced by the model rose dramatically in anticipation of the full height of crises in 1988.