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The double play: simultaneous speculative attacks on currency and equity markets

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  • Sujit Chakravorti
  • Subir Lall

Abstract

This paper investigates the potential for foreign speculators to profit from simultaneously taking short positions in foreign exchange and equity markets under a fixed exchange rate regime, in what has been termed as the double play. Such a strategy is considered when the monetary authority is faced with two conflicting objectives exchange rate stability and low interest rates. While the monetary authority may not be able to directly intervene to stabilize interest rates under the fixed exchange rate regime, it may consider intervention in equity markets to head off speculative pressure on interest rates. The model determines market conditions where speculators may find the double play strategy profitable and the impact of government intervention on speculative short equity positions and the interest rate, concluding that intervention can never simultaneously reduce speculation in the equity and the money markets. In the case where country fundamentals are strong, intervention while reducing short positions in equity markets actually increases short positions in the money market and induces higher interest rates. The paper concludes by discussing the Hong Kong Monetary Authority's intervention in the Hong Kong equity market within the context of this model.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-00-17.

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Date of creation: 2000
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Handle: RePEc:fip:fedhwp:wp-00-17

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Keywords: Economic stabilization ; Foreign exchange rates ; Stock exchanges;

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References

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  1. Obstfeld, Maurice, 1996. "Models of Currency Crises with Self-fulfilling Features," CEPR Discussion Papers 1315, C.E.P.R. Discussion Papers.
  2. Ozkan, F Gulcin & Sutherland, Alan, 1995. "Policy Measures to Avoid a Currency Crisis," Economic Journal, Royal Economic Society, vol. 105(429), pages 510-19, March.
  3. 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.
  4. Subir Lall, 1997. "Speculative Attacks, Forward Market Intervention and the Classic Bear Squeeze," IMF Working Papers 97/164, International Monetary Fund.
  5. 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.
  6. Jarrow, Robert A., 1992. "Market Manipulation, Bubbles, Corners, and Short Squeezes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(03), pages 311-336, September.
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Cited by:
  1. Schmukler, Sergio L. & Serven, Luis, 2002. "Pricing currency risk : facts and puzzles from currency boards," Policy Research Working Paper Series 2815, The World Bank.
  2. Basant K. Kapur, 2007. "Capital Flows and Exchange Rate Volatility: Singapore’s Experience," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 575-608 National Bureau of Economic Research, Inc.
  3. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 2001. "The Role of Large Players in Currency Crises," NBER Working Papers 8303, National Bureau of Economic Research, Inc.

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