CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

35.3 THE CASE OF EMERGING MARKETS

The 1997 Asian currency crisis brought to the foreground concerns about global macro funds and their possible role in exacerbating financial market volatility and disrupting emerging markets. Some Asian government officials explicitly accused hedge funds of attacking their currencies and causing their downfalls. Specifically, Malaysia's prime minister, Mahathir Mohammad, argued that by accumulating very large and concentrated short speculative positions (referred to as big elephants in small ponds), hedge funds had destabilized the foreign exchange, money, and equity markets of Thailand, Malaysia, Indonesia, and the Philippines. Several governments also raised concerns about aggressive and manipulative tactics used by some global macro hedge funds, which might have compromised market integrity and interfered with a normal price-discovery process (see Brown, Goetzmann, and Park [1998] for further discussion).

While the trading activity of hedge funds may have sped up the devaluation process, there was no doubt that many of these currencies were fundamentally weak. Black (2004) explains how the supply and demand for currency can be monitored using the balances of the current account and capital account balances as well as the level of official reserves. For freely floating currencies, a country with net capital inflows would likely see an appreciating currency, while depreciation would be expected with net capital outflows. The current account measures ...