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Imperfect Common Knowledge in First-Generation Models of Currency Crises

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  • Gara Minguez-Afonso

    (London School of Economics)

Abstract

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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Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 3 (2007)
Issue (Month): 1 (March)
Pages: 81-112

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Handle: RePEc:ijc:ijcjou:y:2007:q:1:a:3

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  1. Pastine, Ivan, 2001. "Speculation and the Decision to Abandon a Fixed Exchange Rate Regime," CEPR Discussion Papers 2893, C.E.P.R. Discussion Papers.
  2. Dilip Abreu & Markus K. Brunnermeier, 2003. "Bubbles and Crashes," Econometrica, Econometric Society, vol. 71(1), pages 173-204, January.
  3. Martin J Osborne & Ariel Rubinstein, 2009. "A Course in Game Theory," Levine's Bibliography 814577000000000225, UCLA Department of Economics.
  4. Fernando A. Broner, 2004. "Discrete Devaluations and Multiple Equilibria in a First Generation Model of Currency Crises," 2004 Meeting Papers 264, Society for Economic Dynamics.
  5. Nancy P. Marion & Robert P. Flood, 1998. "Perspectiveson the Recent Currency Crisis Literature," IMF Working Papers 98/130, International Monetary Fund.
  6. Guimaraes, Bernardo, 2006. "Dynamics of currency crises with asset market frictions," Journal of International Economics, Elsevier, vol. 68(1), pages 141-158, January.
  7. Markus K Brunnermeier & John Morgan, 2004. "Clock Games: Theory and Experiments," Levine's Bibliography 122247000000000401, UCLA Department of Economics.
  8. Gara Minguez-Afonso, 2007. "Imperfect Common Knowledge in First-Generation Models of Currency Crises," International Journal of Central Banking, International Journal of Central Banking, vol. 3(1), pages 81-112, March.
  9. Salant, Stephen W & Henderson, Dale W, 1978. "Market Anticipations of Government Policies and the Price of Gold," Journal of Political Economy, University of Chicago Press, vol. 86(4), pages 627-48, August.
  10. Stephen W. Salant & Dale W. Henderson, 1976. "Market anticipations, government policy, and the price of gold," International Finance Discussion Papers 81, Board of Governors of the Federal Reserve System (U.S.).
  11. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
  12. Rochon, Celine, 2006. "Devaluation without common knowledge," Journal of International Economics, Elsevier, vol. 70(2), pages 470-489, December.
  13. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  14. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August.
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Cited by:
  1. Tijmen Daniëls & Henk Jager & Franc Klaassen, 2009. "Defending Against Speculative Attacks," SFB 649 Discussion Papers SFB649DP2009-011, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  2. Gara Minguez-Afonso, 2006. "Imperfect common knowledge in first generation models of currency crises," LSE Research Online Documents on Economics 24509, London School of Economics and Political Science, LSE Library.
  3. Gara Minguez-Afonso, 2007. "Imperfect Common Knowledge in First-Generation Models of Currency Crises," International Journal of Central Banking, International Journal of Central Banking, vol. 3(1), pages 81-112, March.
  4. Mei Li & Frank Milne, 2007. "The Role of Large Players in a Dynamic Currency Attack Game," Working Papers 1148, Queen's University, Department of Economics.

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