Expectations and Information in Second Generation Currency Crises Models

The paper explores the role of expectations in second generation currency crises models, providing an explanation for sudden shifts in speculators' behaviour that trigger currency devaluations, even without any sizeable worsening of the fundamentals of the economy. By focusing on expectations, we show that 'small' (mean-preserving) changes of speculators' probability assessment over the state of fundamentals may be sufficient to drive agents on a unique 'bad' equilibrium with a self-fulfilling attack that forces the government to devaluate the currency. Following a recent line of research, we also examine the role of information and that of common knowledge of agents' actions for the result of multiple equilibria. Unlike private information models, that entail a unique equilibrium for each level of the fundamentals, public information games, by restoring the common knowledge of players' actions, maintain multiple equilibria. Interestingly, by comparing the results of the two models, the following paradox emerges: providing public information seems to be more convenient when fundamentals are bad. An inspection on the reasons behind this paradox gives an illustration of how misleading conclusions might be when drawn from models with multiple equilibria, especially when considerations on the likelihood of the outcomes are neglected.