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Expectations and Contagion in Self-fulfilling Currency Attacks

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Author Info
Todd Keister () (Research and Statistics Group Federal Reserve Bank of New York)

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Abstract

This paper shows how expectations-driven contagion of currency crises can arise even if the currency market has a unique equilibrium when viewed in isolation. The model of Morris and Shin (1998) is extended to allow speculators to trade in a second currency market. If speculators believe that a devaluation of this other currency will make a domestic devaluation more likely, they will engage in trades that link the two markets. A sharp devaluation of the other currency will then be propagated to the domestic market and will increase the likelihood of a crisis there, fulfilling the original expectations. Even though this contagion is driven solely by expectations, the model places restrictions on observable variables, and these restrictions are broadly consistent with existing empirical evidence

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 485.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:485

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Related research
Keywords: Contagion; Currency Crisis; Coordination; Global Games;

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information

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  2. Glick, Reuven & Rose, Andrew K., 1999. "Contagion and trade: Why are currency crises regional?," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 603-617, August. [Downloadable!] (restricted)
    Other versions:
  3. John C. Harsanyi & Reinhard Selten, 1988. "A General Theory of Equilibrium Selection in Games," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582384.
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  6. 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.
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  12. Ennis, Huberto M. & Keister, Todd, 2005. "Government policy and the probability of coordination failures," European Economic Review, Elsevier, vol. 49(4), pages 939-973, May. [Downloadable!] (restricted)
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  18. Masson, Paul, 1999. "Contagion:: macroeconomic models with multiple equilibria," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 587-602, August. [Downloadable!] (restricted)
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  22. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April. [Downloadable!] (restricted)
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  28. Amil Dasgupta, 2004. "Financial Contagion Through Capital Connections: A Model of the Origin and Spread of Bank Panics," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 1049-1084, December. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jean-Marc Tallon, 2006. "Incertitude stratégique et sélection d'équilibre : deux applications," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00177058_v1, HAL. [Downloadable!]
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