First-generation models assume that the level of reserves of a central bank is common knowledge among arbitrageurs, and therefore the timing of the attack on the currency can be correctly anticipated. The collapse of the peg thus leads to no discrete change in the exchange rate. We relax the assumption of perfect information and introduce uncertainty about the willingness of a central bank to defend the peg. In this new setting, there is a unique equilibrium at which the fixed exchange rate is abandoned. The lack of common knowledge will lead to a discrete devaluation once the peg finally collapses.
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Find related papers by JEL classification: D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies F31 - International Economics - - International Finance - - - Foreign Exchange
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Dilip Abreu & Markus K. Brunnermeier, 2003.
"Bubbles and Crashes,"
Econometrica,
Econometric Society, vol. 71(1), pages 173-204, January.
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