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The Role of Large Players in a Dynamic Currency Attack Game

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  • Mei Li

    ()
    (Queen's University)

  • Frank Milne

    ()
    (Queen's University)

Abstract

We establish a dynamic currency attack model in the presence of a large player (LP) based on Abreu and Brunnermeier (2003), which differs from most existing one-period static currency attack models. In an attack on a fixed exchange rate regime with a gradually overvaluing currency, both the inability of speculators to synchronize their attack and their incentive to time the collapse of the regime lead to the persistent overvaluation of the currency. We find that the presence of an LP, who is defined as a speculator with more wealth and superior information, can accelerate or delay the collapse of the regime, depending on his incentives to preempt other speculators or to "ride the overvaluation". When an LP's incentive to preempt other speculators is dominant, the presence of an LP will accelerate the collapse of the regime. However, when an LP's incentive to "ride the overvaluation" is dominant, the presence of an LP will delay the collapse of the regime. The latter case provides valuable insights into the role that LP's play in currency attacks: It differs from the usual perception that the presence of LPs will facilitate arbitrage in an asset market and alleviate asset mispricing due to their capability and willingness to arbitrage.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1148.pdf
File Function: First version 2007
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1148.

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Length: 24 pages
Date of creation: Sep 2007
Date of revision:
Handle: RePEc:qed:wpaper:1148

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Keywords: Large Player; Currency Attack;

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  1. Bannier, Christina E., 2005. "Big elephants in small ponds: Do large traders make financial markets more aggressive?," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1517-1531, November.
  2. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
  3. Markus K Brunnermeier, 2002. "Bubbles and Crashes," FMG Discussion Papers dp401, Financial Markets Group.
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  11. Jeanne, Olivier, 1999. "Currency Crises: A Perspective on Recent Theoretical Developments," CEPR Discussion Papers 2170, C.E.P.R. Discussion Papers.
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  13. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
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  15. Christophe Chamley, 2003. "Dynamic Speculative Attacks," American Economic Review, American Economic Association, vol. 93(3), pages 603-621, June.
  16. Rochon, Celine, 2006. "Devaluation without common knowledge," Journal of International Economics, Elsevier, vol. 70(2), pages 470-489, December.
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