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A Twin Crisis Model Inspired by the Asian Crisis

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  • Irina Bunda

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    (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans)

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    Abstract

    In this paper, we propose a twin crises synthetic model. We show that there may be multiple equilibria on the exchange market as well as on the international financial one and emphasize the possible connections between currency and financial crises. On the exchange market, the currency devaluation is the outcome of a trade-off by the government in presence of implicit safety nets of the banking sector. The crisis occurs whenever the anticipated devaluation rate by the market is equal to the "optimal" devaluation rate of the government. As far as the international financial market is concerned, the passage from one equilibrium to another is triggered by the evolution of the ratio Currency Reserves/Short Term Debt as a fundamental factor. Combining bank run dynamics and fundamental factors, we aim at reconciling the two major interpretations of currency and banking crises, namely the fragility of emerging financial systems and the ex-post worsening of domestic fundamentals originating in debtors or domestic government moral hazard.

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    Bibliographic Info

    Paper provided by HAL in its series Working Papers with number hal-00422507.

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    Date of creation: 2006
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    Handle: RePEc:hal:wpaper:hal-00422507

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    Related research

    Keywords: twin crises models; multiple equilibria; bank runs; capital flows;

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    1. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
    2. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc.
    3. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "Paper tigers?: A model of the Asian crisis," European Economic Review, Elsevier, vol. 43(7), pages 1211-1236, June.
    4. Bris, Arturo & Koskinen, Yrjo, 2002. "Corporate leverage and currency crises," Journal of Financial Economics, Elsevier, vol. 63(2), pages 275-310, February.
    5. Martin Schneider & Aaron Tornell, 2000. "Balance SHeet Effects, Bailout Guarantees and Financial Crises," NBER Working Papers 8060, National Bureau of Economic Research, Inc.
    6. Robert Dekle & Kenneth M. Kletzer, 2001. "Domestic Bank Regulation and Financial Crises: Theory and Empirical Evidence from East Asia," NBER Working Papers 8322, National Bureau of Economic Research, Inc.
    7. Kenneth Kletzer & Robert Dekle, 2001. "Domestic Bank Regulation and Financial Crises," IMF Working Papers 01/63, International Monetary Fund.
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