The Mexican crisis of 1994–95 had strong spillover effects on other countries. This study of how capital markets reacted to each policy announcement and piece of breaking news during the crisis reveals that the market welcomed announcements that reflected Argentina's adoption of credible policies and firm commitment to the currency board.
Argentina was hit hard by the Mexican crisis of 1994–95. The Argentine peso came under attack and there was a run on bank deposits. Argentina successfully announced a series of policies to mitigate the spillover effects, without abandoning its currency board.
Ganapolsky and Schmukler show how capital markets reacted to each policy announcement and piece of breaking news.
They find that Argentina's agreement with the International Monetary Fund, the dollarization of reserve deposits in the central bank, and the reduction in reserve requirements, among other things, had a strong positive impact on market returns. The market welcomed announcements that reflected the adoption of credible policies and demonstrated a firm commitment to the currency board.
The authors also find that, after a period of higher volatility, the appointment of a new finance minister (after Domingo Cavallo left the finance ministry) calmed down stock and bond markets, significantly decreasing the variance in stock and bond market returns. On the other hand, the interest rate became more volatile after the appointment of the new finance minister and when reserve requirements were lowered.
This paper—a product of Macroeconomics and Growth, Development Research Group—is part of a larger effort in the group to understand how financial markets work. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Emily Khine, room MC3-347, telephone 202-473-7471, fax 202-522-3518, Internet address kkhine@worldbank.org. Sergio Schmukler may be contacted at sschmukler@worldbank.org. (34 pages)
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