Financial Crisis: A Case on Turkey

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**Chapter 5**

Times

*Dogus Emin*

behaviors change during shock periods.

emerging markets

**1. Introduction**

**79**

**Abstract**

External Factors on Turkish

Short-Term Interest Rates and

Daily Exchange Rates: Tranquil

Periods versus Politically Stressed

This chapter studies the impacts of short-term interest rates of United States and emerging markets risk premia as external factors on Turkish short-term interest rates and daily exchange rates during the period of January 2011–December 2018. Following Edwards and Borensztein et al., we construct a vector autoregressive (VAR) model with the domestic short-term interest rates, exchange rate against the US Dollar, the US interest rates and iShares MSCI emerging markets ETF. Hereby, we intend to shed some light on the reaction of Turkish interest rates and exchange rates to the short-term US interest rates and emerging markets instability. As other emerging countries, Turkey is rather economically and politically unstable country. Even a little political development may cause a serious volatility in the market. For that reason, in this study we specifically examine the periods that are known as politically stressed times and tranquil periods separately to see how external factors'

**Keywords:** interest rate contagion, exchange rate, VAR model, financial crisis,

The risk exposures from the US during the 2007–2009 financial crisis spread rapidly to the global financial markets and gradually increased its severity while the great number of banks bankrupted due to increase in interest rates. The major role for the bankruptcies of the banks in European countries was the domino effect of the spread of interest rate risk in the interbank market and liquidity risk (e.g., [1, 2]). Since the liquidity risks correspond to counterparty risk, the idiosyncratic credit problems arising from the US subprime mortgage market spread rapidly to other countries through the channels of changes in interest rate (e.g., [2–5]). Brunnermeier and Pedersen [3] empirically show that increase in interest rates affect the financial institutions that have liquidity problems as those institutions are more open to risk contagion arising from the interest rate rise. "For this reason, banks, which carry interbank credit risk threats, are exposed to liquidity risks and such a systemic risk contagion causes subsequent bankruptcies (see e.g., [6–11])" ([12], p. 243).
