The impact of the Japanese banking crisis on the intraday FX market in late 1997

Using the tick-by-tick yen/dollar exchange rate, this paper examines the effect of Japanese banking crises in late 1997 on the foreign exchange rate market. By high-frequency methodology, GARCH estimation and variance-ratio tests, the existence of a structural break in the foreign exchange market at the onset of the crisis is detected. We show a reversed pattern in return volatility after the series of bankruptcies. From the microstructure analysis, it is found that the change in exchange rate dynamics can be attributed to a change in strategic foreign exchange trade behavior. The result provides new insights into the trading activities of market makers at the onset of bank failures.