Learning, large deviations, and recurrent currency crises
AbstractThis paper studies a version of Obstfeld's (1997) "escape clause" model. The model is calibrated to produce three rational expectations equilibria. Two of these equilibria are E-stable in the sense of Evans (1985), and one is unstable. Dynamics are introduced by assuming that agents must learn about the government's decision rule. It is assumed they do this using a stochastic approximation algorithm. It turns out that as a certain parameter describing the sensitivity of beliefs to new information gets small, the algorithm converges weakly to a small noise diffusion process. The dynamics of exchange rate changes are then characterized using large deviation techniques from Freidlin and Wentzell (1998). These methods describe the sense in which the limiting distribution of exchange rate changes is approximated by a two-state Markov-switching process, where the two states correspond to the two E-stable equilibria of the algorithm's mean dynamics. The analysis relates the parameters of this process to assumptions about learning and the stochastic properties of the underlying shocks. ; The model is applied to the exchange rate histories of Argentina, Brazil, and Mexico. Although two-state Markov-switching models describe these countries' exchange rate histories quite well, they have little ex ante predictive power. Of more interest to this paper, however, is the finding that observed currency crises look a lot like the predicted 'escape routes' of the calibrated escape clause model, augmented with an adaptive learning rule. A key feature of these escape routes is that expectations of a devaluation erupt suddenly, without any large contemporaneous shocks. This is consistent with evidence showing that crises are often poorly anticipated by financial markets.
Download InfoTo our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
Bibliographic InfoPaper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2000-10.
Date of creation: 2000
Date of revision:
Publication status: Published in International Economic Review (February 2004, v. 45 no. 1, p141-173)
Other versions of this item:
- Kenneth Kasa, 2004. "Learning, Large Deviations, And Recurrent Currency Crises," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(1), pages 141-173, 02.
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page. reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Diane Rosenberger).
If references are entirely missing, you can add them using this form.