The choice of exchange rate regime in developing countries carries critical importance to their self-protection from speculative attacks and currency crises, as well as achievement of long-term economic growth. Deep integration of developing countries to the global economy makes it difficult to keep the intermediate regime between the two polar solutions. Shifting to more extreme choices between free floating and credible institutional arrangement (monetary union, currency board, or even dollarization) is recommended for many developing countries.

This paper examines the viability or appropriateness of two polar solutions, especially free-floating regime for developing countries. To do so, We investigate the Korean financial markets, which provide interesting case, utilizing multivariate GARCH and various VAR (Vector Auto-Regression) tools. We find that the slightest sign of either weakness of domestic economy or fragility of international financial markets might cause foreign investors to flock out of Korean financial markets and result in inviting another turmoil in Korea. In a limited sense, it is fair to say that the current transitory period from managed to flexible exchange rate regime is a very vulnerable period for Korean economy, and we need to be well equipped to another near international financial turmoil.

Executive Summary

Ⅰ. Introduction

Ⅱ. Choice of Exchange Rate Regime in Developing Countries
1. Brief History of International Exchange Rate System
2. Issues on Choice of Exchange Rate Arrangement
3. Lessons and Issues from Recent Currency Crises

Ⅲ. Recent Financial Market Developments in Korea
1. Methodology
2. Data Description
3. Empirical Results
4. Findings from Survey Data on Foreign Exchange Risk Management

Ⅳ. Conclusion

References