Managing foreign exchange risk: the Malaysian experience in the 1997 financial crisis

Abstract

This paper gives an overview of some important factors that cause exchange-rate volatility and the key economic indicators that influence the probability of a crisis and its depth. It examines the Malaysian currency peg that has been in place since September 1998, using selected key economic indicators to examine whether the currency peg is a sustainable solution for managing foreign exchange risk. It also reviews the benefits and challenges of common currency and evaluates whether the implementation of a common currency could effectively reduce foreign exchange risk for Malaysia and ASEAN countries. There are three major findings presented. First, the volatility partners and competitors in the postcrisis period was against the Thai baht. Second, the currency peg is not a long-term solution for managing foreign exchange risk. Third and last, forming a synthetic common currency using data for the period 1996 to 2001, significant diversifiable risk—around 90 percent—is found in all individual currencies.

JEL classification: E42, F31, F33, G15