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Defending Against Speculative Attacks: Reputation, Learning, and Coordination

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  • Chong Huang

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    (Department of Economics, University of Pennsylvania)

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    Abstract

    How does the central bank's incentive to build a reputation affect speculators' ability to coordinate and the likelihood of the devaluation outcome during speculative currency crises? What role does market information play in speculators' coordination and the central bank's reputation building? I address these questions in a dynamic regime change game that highlights the interaction between the central bank's reputation building and speculators' individual learning. On the one hand, the central bank has private information about its value from the currency peg and decides whether to maintain it. By defending against speculative attacks, it can build a reputation of defending, which may deter future attacks. On the other hand, speculators individually learn the central bank's value, and such learning may encourage speculators to coordinate an attack. I show that though learning makes the central bank's value approximate common knowledge over time, there is a unique equilibrium when learning is slow. In this equilibrium, no speculator attacks and the central bank sustains the currency peg forever, because the central bank obtains commitment power through the incentive to build a reputation. When learning is fast, there may be equilibria with attacks. In any equilibrium with attacks, the onset of the attack depends on the entire learning process. Once speculators attack, they attack frequently and infinitely often. Consequently, the central bank has no incentive to build a reputation and abandons the currency peg almost surely.

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    Bibliographic Info

    Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 11-039.

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    Length: 39 pages
    Date of creation: 15 Nov 2011
    Date of revision:
    Handle: RePEc:pen:papers:11-039

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    Keywords: Speculative attacks; Reputation; Coordination; Common Learning;

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    1. Fernando A. Broner, 2004. "Discrete Devaluations and Multiple Equilibria in a First Generation Model of Currency Crises," 2004 Meeting Papers, Society for Economic Dynamics 264, Society for Economic Dynamics.
    2. Giannitsarou, Chryssi & Toxvaerd, Flavio, 2007. "Recursive Global Games," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6470, C.E.P.R. Discussion Papers.
    3. Wiseman, Thomas, 2009. "Reputation and exogenous private learning," Journal of Economic Theory, Elsevier, Elsevier, vol. 144(3), pages 1352-1357, May.
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    6. Dasgupta, Amil & Steiner, Jakub & Stewart, Colin, 2012. "Dynamic coordination with individual learning," Games and Economic Behavior, Elsevier, Elsevier, vol. 74(1), pages 83-101.
    7. Chris Edmond, 2011. "Information Manipulation, Coordination, and Regime Change," NBER Working Papers 17395, National Bureau of Economic Research, Inc.
    8. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2007. "Dynamic Global Games of Regime Change: Learning, Multiplicity, and the Timing of Attacks," Econometrica, Econometric Society, Econometric Society, vol. 75(3), pages 711-756, 05.
    9. Salant, Stephen W & Henderson, Dale W, 1978. "Market Anticipations of Government Policies and the Price of Gold," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 86(4), pages 627-48, August.
    10. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2004. "Coordination and Policy Traps," Levine's Bibliography 122247000000000294, UCLA Department of Economics.
    11. Salant, Stephen W, 1983. "The Vulnerability of Price Stabilization Schemes to Speculative Attack," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(1), pages 1-38, February.
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