"[2][3] Sudden stops are commonly described as periods that contain at least one observation where the year-on-year fall in capital flows lies at least two standard deviations below its sample mean.
[4] The start of the sudden stop period is determined by the first time the annual change in capital flows falls one standard deviation below the mean and the end of the sudden stop period is determined once the annual change in capital flows exceeds one standard deviation below its sample mean.
Therefore, a large slowdown in capital inflows is met either by a loss of international reserves and/or a lower current account deficit, both of which have negative economic effects.
The features of sudden stops are similar to those of balance of payment crises in terms of devaluations of the domestic currency followed by periods of output loss.
[5] The mechanism is explained by a credit based approach to currency crises, where countries with less developed financial markets experience a sharper output fall during a sudden stop episode, regardless of whether the country has a fixed or floating exchange rate regime, as the source of the crisis is through the deterioration of private firms’ balance sheets.
[7] Emerging markets are characterized by frequent regime switches related to changes in fiscal, monetary and trade policies, which reflect in more volatile shocks to the trend.
In order to study sudden stop episodes, using data from the 1994 economic crisis in Mexico, this model decomposes it to obtain a representation of transitory and permanent technology shocks.
There is a distinguishable boom–bust cycle, as unsustainable massive capital inflows that precede a sudden stop episode sharply increase economic activity.
Other studies focus on the relationship between current account reversals and sudden stops in both emerging markets and advanced economies.
In the case of developed economies, sudden stop episodes occur around the European Exchange Rate Mechanism (ERM) (1992–1993) crisis.
Real interest rates sharply increase during sudden stop episodes, especially in the case of emerging market economies.
A sharp loss of international reserves is also observed during sudden stop episodes, both in developed countries and emerging markets.