Learning, large deviations, and recurrent currency crises
This paper studies a version of Obstfeld's (1997) "escape clause" model. The model is calibrated to produce three rational expectations equilibria. Two of these equilibria are E-stable in the sense of Evans (1985), and one is unstable. Dynamics are introduced by assuming that agents must learn about the government's decision rule. It is assumed they do this using a stochastic approximation algorithm. It turns out that as a certain parameter describing the sensitivity of beliefs to new information gets small, the algorithm converges weakly to a small noise diffusion process. The dynamics of exchange rate changes are then characterized using large deviation techniques from Freidlin and Wentzell (1998). These methods describe the sense in which the limiting distribution of exchange rate changes is approximated by a two-state Markov-switching process, where the two states correspond to the two E-stable equilibria of the algorithm's mean dynamics. The analysis relates the parameters of this process to assumptions about learning and the stochastic properties of the underlying shocks. ; The model is applied to the exchange rate histories of Argentina, Brazil, and Mexico. Although two-state Markov-switching models describe these countries' exchange rate histories quite well, they have little ex ante predictive power. Of more interest to this paper, however, is the finding that observed currency crises look a lot like the predicted 'escape routes' of the calibrated escape clause model, augmented with an adaptive learning rule. A key feature of these escape routes is that expectations of a devaluation erupt suddenly, without any large contemporaneous shocks. This is consistent with evidence showing that crises are often poorly anticipated by financial markets.
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||2000|
|Publication status:||Published in International Economic Review (February 2004, v. 45 no. 1, p141-173)|
|Contact details of provider:|| Postal: P.O. Box 7702, San Francisco, CA 94120-7702|
Phone: (415) 974-2000
Fax: (415) 974-3333
Web page: http://www.frbsf.org/
More information through EDIRC
|Order Information:|| Email: |
When requesting a correction, please mention this item's handle: RePEc:fip:fedfwp:2000-10. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Noah Pollaczek)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.