**3. Results**

premia. However, during the politically stressed periods it is not possible to estimate the relations between those variables as each political stress may have a different impact according to their dynamics. For instance, while a fully domestic political stress may cause Turkish financial markets to separate from the rest of the world, a political stress that is caused by an international development may cause

"The vector autoregression (VAR) model is one of the most successful, flexible, and easy to use models for the analysis of multivariate time series" ([27], p. 385). It is a natural extension of the univariate autoregressive model to dynamic multi-

Let *Yt = (y1t, y2t, … , ynt)'* denote an *(n* � *1)* vector of time series variables. The

where *Π<sup>i</sup>* are *(n* � *n)* coefficient matrices and *ε<sup>t</sup>* is an *(n* � *1)* unobservable zero

According to this, for example, a bivariate VAR(2) model equation by equation has

<sup>12</sup>*Y*2*t*�<sup>1</sup> <sup>þ</sup> *<sup>π</sup>*<sup>1</sup>

<sup>22</sup>*Y*2*t*�<sup>1</sup> <sup>þ</sup> *<sup>π</sup>*<sup>1</sup>

where *cov(ε*1*<sup>t</sup>*, *ε*2*<sup>t</sup>*Þ ¼ *σ*12. Each equation has the same regressors-lagged values of

. Hence the VAR(p) model is just a seemingly unrelated regression (SUR)

mean White noise vector process with time invariant covariance matrix Σ.

model with lagged variables and deterministic terms as common regressors.

where *<sup>Π</sup>*ð Þ¼ *<sup>L</sup> In* � *<sup>Π</sup>*1*<sup>L</sup>* � … � *<sup>Π</sup>pL<sup>p</sup>*. The VAR(p) is stable if the roots of

<sup>1</sup> The theoretical presentation of vector autoregressive models that is used in the Methodology part is

<sup>11</sup>*Y*1*t*�<sup>1</sup> <sup>þ</sup> *<sup>π</sup>*<sup>1</sup>

<sup>21</sup>*Y*1*t*�<sup>1</sup> <sup>þ</sup> *<sup>π</sup>*<sup>1</sup>

In lag operator notation, the VAR(p) is written as;

*Yt* ¼ c þ *Π*1*Yt*�<sup>1</sup> þ *Π*2*Yt*�<sup>2</sup> þ … þ þ*ΠpYt*�*<sup>p</sup>* þ *εt*, *t* ¼ 1, … , *T* (2)

<sup>11</sup>*Y*1*t*�<sup>2</sup> <sup>þ</sup> *<sup>π</sup>*<sup>2</sup>

<sup>21</sup>*Y*1*t*�<sup>1</sup> <sup>þ</sup> *<sup>π</sup>*<sup>2</sup>

*Π*ð Þ *L Yt* ¼ c þ *ε<sup>t</sup>* (5)

<sup>12</sup>*Y*2*t*�<sup>2</sup> þ *ε*1*<sup>t</sup>* (3)

<sup>22</sup>*Y*2*t*�<sup>1</sup> þ *ε*2*<sup>t</sup>* (4)

Turkish markets to more sensitive to the external shocks.

*Emerging markets risk premia, short-term interest rate of Turkey and USD/TRY.*

*Financial Crises - A Selection of Readings*

basic *p-lag* vector autoregressive model has the form;

*<sup>y</sup>*1*<sup>t</sup>* <sup>¼</sup> *<sup>c</sup>*<sup>1</sup> <sup>þ</sup> *<sup>π</sup>*<sup>1</sup>

*<sup>y</sup>*2*<sup>t</sup>* <sup>¼</sup> *<sup>c</sup>*<sup>1</sup> <sup>þ</sup> *<sup>π</sup>*<sup>1</sup>

taken from the book of Zivot and Wang [26].

variate time series.<sup>1</sup>

the form;

**Figure 3.**

*y*1*<sup>t</sup>* and *y*2*<sup>t</sup>*

**84**

In this study, to be able to show how the impact of external shocks on domestic interest rates and the exchange rates change according to political stress in Turkey, we construct a VAR model. **Figure 4** plots interest rates and exchange rates in Turkey over the period of 2011–2019. The politically stressed periods are highlighted on this figure to show how domestic interest rates and exchange rates react to political developments. Therefore, eight shaded lines on **Figure 4** identify the following major political crises in Turkey;


January 2011 to 31 December 2018, I estimate a VAR model including domestic 3-months interest rates, the logarithm of the nominal exchange rate against the US Dollar, 3-months US interest rates and iShares MSCI Emerging Markets ETF. To be able to eliminate the serial correlation in the residuals, we use a specification with 3 lags. By following ([16], p. 12) "in order to identify the impulse responses, errors

*External Factors on Turkish Short-Term Interest Rates and Daily Exchange Rates: Tranquil…*

VAR test reveals that for the period of 2011–2019, Turkish short-term interest rates and the USD/TRY exchange rate are not significantly affected by the US shortterm interest rates in the short run. However, after our preliminary analysis, we increase the lag lengths to see if the US short-term interest rates have significant impact on Turkish interest rates and the exchange rate in longer term. The results reveal that while the exchange rate is not affected by the US short-term interest rates even in longer term; with 10 days lag interval the US short-term interest rates has a significant impact on the Turkish short-term interest rates at 90% confidence level. Therefore, for the examined period, we conclude that while the US short-term interest rates do not affect exchange rates in Turkey, Turkish short-term interest rates show a significant positive response to the shocks from the US after 10 days. When we examine the impact of emerging markets on Turkish short-term interest rates and exchange rates we see that, emerging market risk premia has a stronger effect compared to the short-term US interest rates. According to that, the shocks coming from the emerging markets significantly affect the Turkish shortterm interest rates and USD/TRY in the first 2 days. Unlike the US short-term interest rates, the impact of the emerging markets risk premia on the Turkish short-

term interest rates and Turkish exchange rate disappear in the longer term.

emerging market risk premia.

peak on the 9th day.

**87**

in Turkey are significantly affected by the US rates.

To be able to explain the general pattern of the response of Turkish short-term interest rates and the exchange rate to the US short-term interest rates and the emerging market risk premia we perform the impulse response functions.

**Figure 5** presents the impulse response functions of short-term interest rates of Turkey and USD/TRY exchange rate to the short-term interest rates of USA and the

**Figure 5** shows the impulse response functions of USD/TRY and the Turkish short-term interest rates to one percentage point US interest rate shock and emerging market risk premia shock. First, it is worth noting that the impact of the US interest rate shock to the exchange rate reaches its peak after 1 week while the impact of the US short-term interest rate shock to the Turkish short-term interest rates reaches its peak after 10 days. The interesting point is, while the US interest shocks affect Turkish exchange rate positively during the first 4 days, after the 4th day it starts to have a negative impact. However, the estimated impact on the exchange rate is not significantly different from zero during 10 days period, confirming that the exchange rate in Turkey is not affected by the US interest rates. The impact of the short-term US interest rates become significant on the short-term interest rates of Turkey on the 10th day confirming that short-term interest rates

On the other hand, interest rate and the exchange rate react to emerging market risk premia shocks in a different way. According to that, the Turkish currency responds to emerging markets risk premia significantly and drastically on the first few days with increasing trend after the fourth day while Turkish short-term interest rate's response deepens after the fourth day and reaches its

were orthogonalised by a Cholesky decomposition".

*DOI: http://dx.doi.org/10.5772/intechopen.89931*

**3.1 The full period (January 1, 2011–December 31, 2018)**

#### **Figure 4.**

*Short-term interest rates and spot exchange rate in Turkey.*


**Figure 4** presents the graphs of Turkish short-term interest rates and the USD/ TRY exchange rate for the period of 2011–2019. **Figure 4** also highlights the political stress periods to show how interest rate and exchange rate react to the political stresses.

**Figure 4** highlights the political stress periods to show how short-term interest rates and the USD/TRY pair react to the political stresses. As it can be clearly seen from the graph, most of the time political crises coincide with the sharp depreciation of the Turkish Lira against the US Dollar, while interest rates seem to react shortly after the political crises. Political stress #8 which starts with the lawsuit of Pastor Branson seems to have the most remarkable impact on Turkish interest rates which causes a rise from around 17% to above 25%. According to **Figure 4**, Turkish Lira significantly depreciates and short-term interest rates significantly increase in the fourth quarter of 2011, the first quarter of 2017 and the fourth quarter of 2017. However, as we did not identify any political crisis during those periods, we are not in a position to relate these drastic moves with any political stress.

We use VAR analysis to model the behaviour of domestic interest rates and nominal exchange rates. By doing so while our main target is detecting the impact of external shocks on these variables, by identifying the major politically stress periods we also aim to see how political stress makes changes on the impacts of external factors on domestic interest rates and nominal exchange rates. From 1

*External Factors on Turkish Short-Term Interest Rates and Daily Exchange Rates: Tranquil… DOI: http://dx.doi.org/10.5772/intechopen.89931*

January 2011 to 31 December 2018, I estimate a VAR model including domestic 3-months interest rates, the logarithm of the nominal exchange rate against the US Dollar, 3-months US interest rates and iShares MSCI Emerging Markets ETF. To be able to eliminate the serial correlation in the residuals, we use a specification with 3 lags. By following ([16], p. 12) "in order to identify the impulse responses, errors were orthogonalised by a Cholesky decomposition".

#### **3.1 The full period (January 1, 2011–December 31, 2018)**

VAR test reveals that for the period of 2011–2019, Turkish short-term interest rates and the USD/TRY exchange rate are not significantly affected by the US shortterm interest rates in the short run. However, after our preliminary analysis, we increase the lag lengths to see if the US short-term interest rates have significant impact on Turkish interest rates and the exchange rate in longer term. The results reveal that while the exchange rate is not affected by the US short-term interest rates even in longer term; with 10 days lag interval the US short-term interest rates has a significant impact on the Turkish short-term interest rates at 90% confidence level. Therefore, for the examined period, we conclude that while the US short-term interest rates do not affect exchange rates in Turkey, Turkish short-term interest rates show a significant positive response to the shocks from the US after 10 days.

When we examine the impact of emerging markets on Turkish short-term interest rates and exchange rates we see that, emerging market risk premia has a stronger effect compared to the short-term US interest rates. According to that, the shocks coming from the emerging markets significantly affect the Turkish shortterm interest rates and USD/TRY in the first 2 days. Unlike the US short-term interest rates, the impact of the emerging markets risk premia on the Turkish shortterm interest rates and Turkish exchange rate disappear in the longer term.

To be able to explain the general pattern of the response of Turkish short-term interest rates and the exchange rate to the US short-term interest rates and the emerging market risk premia we perform the impulse response functions.

**Figure 5** presents the impulse response functions of short-term interest rates of Turkey and USD/TRY exchange rate to the short-term interest rates of USA and the emerging market risk premia.

**Figure 5** shows the impulse response functions of USD/TRY and the Turkish short-term interest rates to one percentage point US interest rate shock and emerging market risk premia shock. First, it is worth noting that the impact of the US interest rate shock to the exchange rate reaches its peak after 1 week while the impact of the US short-term interest rate shock to the Turkish short-term interest rates reaches its peak after 10 days. The interesting point is, while the US interest shocks affect Turkish exchange rate positively during the first 4 days, after the 4th day it starts to have a negative impact. However, the estimated impact on the exchange rate is not significantly different from zero during 10 days period, confirming that the exchange rate in Turkey is not affected by the US interest rates. The impact of the short-term US interest rates become significant on the short-term interest rates of Turkey on the 10th day confirming that short-term interest rates in Turkey are significantly affected by the US rates.

On the other hand, interest rate and the exchange rate react to emerging market risk premia shocks in a different way. According to that, the Turkish currency responds to emerging markets risk premia significantly and drastically on the first few days with increasing trend after the fourth day while Turkish short-term interest rate's response deepens after the fourth day and reaches its peak on the 9th day.

• 10 days period which starts on 31st July 2014 prior to presidential election,

until the announcement of new elections on 25th August 2015,

border on 24th November 2015,

*Short-term interest rates and spot exchange rate in Turkey.*

*Financial Crises - A Selection of Readings*

Brunson's return to USA.

stresses.

**86**

**Figure 4.**

• The period which starts with the 7th June 2015 general elections and continues

• 2 weeks period which starts with the shootdown of Russian plane on Turkish

• 2 weeks period which starts with the military coup attempt on 15th July 2016,

• 3 months period which starts with the announcement of new cabinet on 2nd July 2018 and strengthens with Pastor Branson's house arrest and ends with

**Figure 4** presents the graphs of Turkish short-term interest rates and the USD/ TRY exchange rate for the period of 2011–2019. **Figure 4** also highlights the political stress periods to show how interest rate and exchange rate react to the political

**Figure 4** highlights the political stress periods to show how short-term interest rates and the USD/TRY pair react to the political stresses. As it can be clearly seen from the graph, most of the time political crises coincide with the sharp depreciation of the Turkish Lira against the US Dollar, while interest rates seem to react shortly after the political crises. Political stress #8 which starts with the lawsuit of Pastor Branson seems to have the most remarkable impact on Turkish interest rates which causes a rise from around 17% to above 25%. According to **Figure 4**, Turkish Lira significantly depreciates and short-term interest rates significantly increase in the fourth quarter of 2011, the first quarter of 2017 and the fourth quarter of 2017. However, as we did not identify any political crisis during those periods, we are not

We use VAR analysis to model the behaviour of domestic interest rates and nominal exchange rates. By doing so while our main target is detecting the impact of external shocks on these variables, by identifying the major politically stress periods we also aim to see how political stress makes changes on the impacts of external factors on domestic interest rates and nominal exchange rates. From 1

in a position to relate these drastic moves with any political stress.

period, neither emerging market risk premia nor the US short-term interest rates significantly affect the short-term interest rates and the exchange rates in Turkey.

*External Factors on Turkish Short-Term Interest Rates and Daily Exchange Rates: Tranquil…*

Prior to 2014 presidential election, Turkish money markets show instability during a 10 days period. During that rather politically stressed period, Borsa Istanbul declines significantly and Turkish Lira depreciates. During this short period, VAR analysis reveals that external shocks do not have any significant impacts on the market. According to that, neither exchange rates nor interest rates respond to any

The fifth political stress has the same impact with the previous stresses as during that period the external factors do not have any significant effect on the short-term interest rates and the exchange rates of Turkey. According to that, during that period, sharp depreciation of the Turkish Lira and the rise in the interest rates occur

The results reveal different conclusion regarding the impacts of the external shocks during the politically stressed times for this specific incident. According that, during the political stress that arises due to shootdown of Russian plane on Turkish border, the Turkish currency is significantly affected by the short-term US interest rates. During that period, Turkish currency significantly responds to the changes on the US short-term interest rates in the first and the second days. During that period, the exchange rate significantly responds to also the emerging risk premia in the second day. However, Turkish short-term interest rates are not significantly affected by any of those external factors during the stress period.

After the military coup attempt, the exchange rate in Turkey starts to show significant response to the shocks that are coming from the emerging markets. During that period emerging risk premia has a significant impact on the short-term interest rates too. Differently from the previous political stress, this time the US short-term interest rates do not have any significant impact on the exchange rate. However, this time, the Turkish short-term interest rate significantly responds to

Probably, in the last decade, Turkey has experienced the deepest financial stress during this politically stress period. Right after Turkey and the USA start to have a serious diplomatic crisis due to trial of Pastor Branson, the Turkish Lira drastically depreciates and Turkish Central Bank has to increase the interest rates dramatically. During that period, our results show that the Turkish Lira and the short-term interest rates are not affected by the external shocks at all. As expected, during that period domestic news play significant role on the value of the Turkish Lira and the

**3.5 The political stress #4 (July 31, 2014–August 15, 2014)**

*DOI: http://dx.doi.org/10.5772/intechopen.89931*

shocks from the US interest rates and the emerging markets.

**3.6 The political stress #5 (June 7, 2015–August 25, 2015)**

**3.8 The political stress #7 (July 15, 2016–July 30, 2016)**

**3.9 The political stress #8 (July 2, 2018–October 2, 2018)**

the shocks coming from the US interest rates.

short-term interest rates.

**89**

**3.7 The political stress #6 (November 24, 2015–November 29, 2015)**

due to domestic developments.

**Figure 5.**

*Impulse response functions: innovations 2 standard errors. Impact on interest rates and exchange rates (logs) of percentage point shock to US interest rates and emerging markets risk.*

#### **3.2 The political stress #1 (July 29, 2011–August 11, 2011)**

During the political stress #1 emerging markets risk premia significantly affects both the USD/TRY pair and the Turkish short-term interest rates. The USD/TRY pair responds significantly on the first day while short-term interest rate responds to the shocks coming from emerging markets on both the first and the second days.

During this politically stressed period, while the US short-term interest rate significantly affects the exchange rate on the second day, it has no significant impact on the short-term interest rates on neither the first nor the second day.

#### **3.3 The political stress #2 (May 28, 2013–June 20, 2013)**

Results reveal that during the political stress #2, neither the Turkish short-term interest rates nor the exchange rate in Turkey are significantly affected by both the US short-term interest rates and the emerging market risk premia. Therefore, we can clearly declare that the Gezi Park incidents cause Turkish capital markets to enter an extra sensitive period to domestic developments while external shocks stop affecting the short-term interest rates and the exchange rate. In other words, during this stressed period, the short-term interest rates and the USD/TRY pair respond to domestic shocks/news instead of external factors.

#### **3.4 The political stress #3 (December 17, 2013–January 3, 2014)**

During the politically stressed period #3, the Turkish Lira depreciates, Borsa Istanbul crashes and interest rates rise significantly. VAR analysis reveals that the reasons of these drastic moves are totally domestic. According to that, during that *External Factors on Turkish Short-Term Interest Rates and Daily Exchange Rates: Tranquil… DOI: http://dx.doi.org/10.5772/intechopen.89931*

period, neither emerging market risk premia nor the US short-term interest rates significantly affect the short-term interest rates and the exchange rates in Turkey.

#### **3.5 The political stress #4 (July 31, 2014–August 15, 2014)**

Prior to 2014 presidential election, Turkish money markets show instability during a 10 days period. During that rather politically stressed period, Borsa Istanbul declines significantly and Turkish Lira depreciates. During this short period, VAR analysis reveals that external shocks do not have any significant impacts on the market. According to that, neither exchange rates nor interest rates respond to any shocks from the US interest rates and the emerging markets.

### **3.6 The political stress #5 (June 7, 2015–August 25, 2015)**

The fifth political stress has the same impact with the previous stresses as during that period the external factors do not have any significant effect on the short-term interest rates and the exchange rates of Turkey. According to that, during that period, sharp depreciation of the Turkish Lira and the rise in the interest rates occur due to domestic developments.

#### **3.7 The political stress #6 (November 24, 2015–November 29, 2015)**

The results reveal different conclusion regarding the impacts of the external shocks during the politically stressed times for this specific incident. According that, during the political stress that arises due to shootdown of Russian plane on Turkish border, the Turkish currency is significantly affected by the short-term US interest rates. During that period, Turkish currency significantly responds to the changes on the US short-term interest rates in the first and the second days. During that period, the exchange rate significantly responds to also the emerging risk premia in the second day. However, Turkish short-term interest rates are not significantly affected by any of those external factors during the stress period.

#### **3.8 The political stress #7 (July 15, 2016–July 30, 2016)**

After the military coup attempt, the exchange rate in Turkey starts to show significant response to the shocks that are coming from the emerging markets. During that period emerging risk premia has a significant impact on the short-term interest rates too. Differently from the previous political stress, this time the US short-term interest rates do not have any significant impact on the exchange rate. However, this time, the Turkish short-term interest rate significantly responds to the shocks coming from the US interest rates.

#### **3.9 The political stress #8 (July 2, 2018–October 2, 2018)**

Probably, in the last decade, Turkey has experienced the deepest financial stress during this politically stress period. Right after Turkey and the USA start to have a serious diplomatic crisis due to trial of Pastor Branson, the Turkish Lira drastically depreciates and Turkish Central Bank has to increase the interest rates dramatically. During that period, our results show that the Turkish Lira and the short-term interest rates are not affected by the external shocks at all. As expected, during that period domestic news play significant role on the value of the Turkish Lira and the short-term interest rates.

**3.2 The political stress #1 (July 29, 2011–August 11, 2011)**

*of percentage point shock to US interest rates and emerging markets risk.*

*Financial Crises - A Selection of Readings*

**Figure 5.**

**88**

**3.3 The political stress #2 (May 28, 2013–June 20, 2013)**

domestic shocks/news instead of external factors.

**3.4 The political stress #3 (December 17, 2013–January 3, 2014)**

During the political stress #1 emerging markets risk premia significantly affects both the USD/TRY pair and the Turkish short-term interest rates. The USD/TRY pair responds significantly on the first day while short-term interest rate responds to the shocks coming from emerging markets on both the first and the second days. During this politically stressed period, while the US short-term interest rate significantly affects the exchange rate on the second day, it has no significant impact on the short-term interest rates on neither the first nor the second day.

*Impulse response functions: innovations 2 standard errors. Impact on interest rates and exchange rates (logs)*

Results reveal that during the political stress #2, neither the Turkish short-term interest rates nor the exchange rate in Turkey are significantly affected by both the US short-term interest rates and the emerging market risk premia. Therefore, we can clearly declare that the Gezi Park incidents cause Turkish capital markets to enter an extra sensitive period to domestic developments while external shocks stop affecting the short-term interest rates and the exchange rate. In other words, during this stressed period, the short-term interest rates and the USD/TRY pair respond to

During the politically stressed period #3, the Turkish Lira depreciates, Borsa Istanbul crashes and interest rates rise significantly. VAR analysis reveals that the reasons of these drastic moves are totally domestic. According to that, during that
