The impact of the Asian financial crisis on foreign exchange market efficiency: The case of East Asian countries

This paper investigates whether the Asian financial crisis in the second half of 1997 affected the foreign exchange market efficiency in four Asian countries hit hard by the crisis: Thailand, Indonesia, Malaysia and Korea. We find that empirical evidence based on the bivariate and multivariate cointegration estimations using the high-frequency data from January 1996 to February 2001 is mostly consistent with the across-country efficient market hypothesis in the Asian foreign exchange markets during the whole sample period except the short period immediately after the July 1997 crisis. Within-country market efficiency also appears to have become weaker immediately after the crisis than before the crisis, but market efficiency was recovered quickly, evidenced by the regained cointegrating relationship for the pairs of the spot-forward exchange rates in the Asian countries. The findings of the threshold effects in the forward market equation and asymmetrical responses of the spot rate to the forward spread imply that there has been a strong force of recovering new equilibrium exchange rate levels in the Asian foreign exchange markets once the rates have been disturbed, especially when their currencies are significantly undervalued compared to the rationally expected level of exchange rates.