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A Theory of the Onset of Currency Attacks

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Abstract

The swiftness and devastating impact of recent financial crises have taken many market participants by surprise, and pose challenges for economists seeking a theory of the onset of a crisis. We propose such a theory based on two features. The actions of diverse economic actors which undermine the currency are mutually reinforcing, while the fragmented nature of the media create small disparities in their information. In such circumstances, the beliefs of market participants can be tracked in the same way as the economic fundamentals, and an attack is triggered when the economic fundamentals deteriorate sufficiently to fall below the minimum level of market confidence necessary to support the currency. We give a characterization of such a minimum level of confidence.

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File URL: http://cowles.econ.yale.edu/P/cd/d12a/d1204.pdf
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Bibliographic Info

Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1204.

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Length: 25 pages
Date of creation: Dec 1998
Date of revision:
Publication status: Published in Agenor, Miller, Vines and Weber, eds., Asian Financial Crisis: Causes, Contagion and Consequences, Cambridge University Press, 1999
Handle: RePEc:cwl:cwldpp:1204

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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: Currency crisis; common knowledge;

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References

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  4. Stephen Morris & Hyun Song Shin, . "Approximate Common Knowledge and Co-ordination: Recent Lessons from Game Theory," Penn CARESS Working Papers 72042421d029130510780dde2, Penn Economics Department.
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  11. Atsushi Kajii & Stephen Morris, . "The Robustness of Equilibria to Incomplete Information," Penn CARESS Working Papers ed504c985fc375cbe719b3f60, Penn Economics Department.
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  16. W. R. M. Perraudin & Manmohan S. Kumar & Uma Moorthy, 2002. "Predicting Emerging Market Currency Crashes," IMF Working Papers 02/7, International Monetary Fund.
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  18. Werlang, Sérgio Ribeiro da Costa, 1988. "Common knowledge," Economics Working Papers (Ensaios Economicos da EPGE) 118, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  19. Rubinstein, Ariel, 1989. "The Electronic Mail Game: Strategic Behavior under "Almost Common Knowledge."," American Economic Review, American Economic Association, vol. 79(3), pages 385-91, June.
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