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Vulnerability of Currency Pegs: Evidence from Brazil

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  • Bernardo Guimaraes

Abstract

This paper analyses predictions of a simple model of currency crises in which the peg will be abandoned when the currency overvaluation hits a certain threshold, unknown to the agents. Due to learning about the threshold, some features usually observed in the data and identified with models with multiple equilibria arise in the model. But the model yields distinctive predictions about the behaviour of the probability and the expected magnitude of a currency devaluation. The paper identifies the probability and expected magnitude of a devaluation of Brazilian Real in the period leading up to the end of the Brazilian pegged exchange rate regime, using data on exchange rate options. The empirical results are consistent with model predictions.

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Bibliographic Info

Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0871.

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Date of creation: Jun 2008
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Handle: RePEc:cep:cepdps:dp0871

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Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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Keywords: Currency crises; exchange rate; options; probability of devaluation; devaluation size;

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