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Imperfect Common Knowledge in First Generation Models of Currency Crises

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  • Gara Minguez Afonso

Abstract

First generation models assume that the level of reserves of a Central Bank in a fixed exchange rate regime is common knowledge among consummers, and therefore the timing of the attack on the currency, in an economy with persistent deficit, can be correctly anticipated. In these models, the collapse of the peg leads to no discrete change in the exchange rate. We relax the assumption of perfect information and introduce uncertainty about the willingness of a Central Bank to defend the peg. In this new setting, there is a unique equilibrium at which the fixed exchange is abandoned. In our model, the lack of common knowledge will lead to a discrete devaluation of the local currency once the peg finally collapses.

Suggested Citation

  • Gara Minguez Afonso, 2006. "Imperfect Common Knowledge in First Generation Models of Currency Crises," FMG Discussion Papers dp555, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp555
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    1. Gara Minguez-Afonso, 2007. "Imperfect Common Knowledge in First-Generation Models of Currency Crises," International Journal of Central Banking, International Journal of Central Banking, vol. 3(1), pages 81-112, March.
    2. Broner, Fernando A., 2008. "Discrete devaluations and multiple equilibria in a first generation model of currency crises," Journal of Monetary Economics, Elsevier, vol. 55(3), pages 592-605, April.
    3. Dilip Abreu & Markus K. Brunnermeier, 2003. "Bubbles and Crashes," Econometrica, Econometric Society, vol. 71(1), pages 173-204, January.
    4. Pastine, Ivan, 2002. "Speculation and the decision to abandon a fixed exchange rate regime," Journal of International Economics, Elsevier, vol. 57(1), pages 197-229, June.
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    7. Celine Rochon, 2006. "Devaluation without common knowledge," Economics Series Working Papers 2006-FE-03, University of Oxford, Department of Economics.
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    11. Flood, Robert & Marion, Nancy, 1999. "Perspectives on the Recent Currency Crisis Literature," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(1), pages 1-26, January.
    12. Celine Rochon, 2006. "Devaluation without common knowledge," OFRC Working Papers Series 2006fe03, Oxford Financial Research Centre.
    13. Guimaraes, Bernardo, 2006. "Dynamics of currency crises with asset market frictions," Journal of International Economics, Elsevier, vol. 68(1), pages 141-158, January.
    14. André Fourçans & Raphaël Franck, 2003. "Currency Crises," Books, Edward Elgar Publishing, number 3124.
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    17. Rochon, Celine, 2006. "Devaluation without common knowledge," Journal of International Economics, Elsevier, vol. 70(2), pages 470-489, December.
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    Cited by:

    1. Li, Mei & Milne, Frank, 2014. "The role of a large trader in a dynamic currency attack model," Journal of Financial Intermediation, Elsevier, vol. 23(4), pages 590-620.
    2. Doblas-Madrid, Antonio, 2016. "A finite model of riding bubbles," Journal of Mathematical Economics, Elsevier, vol. 65(C), pages 154-162.
    3. Gara Minguez-Afonso, 2007. "Imperfect Common Knowledge in First-Generation Models of Currency Crises," International Journal of Central Banking, International Journal of Central Banking, vol. 3(1), pages 81-112, March.
    4. Mei Li & Frank Milne, 2007. "The Role Of Large Players In A Dynamic Currency Attack Game," Working Paper 1148, Economics Department, Queen's University.
    5. Mei Li & Frank Milne, 2010. "A Large Trader in Bubbles and Crashes: an Application to Currency Attacks," Working Papers 1004, University of Guelph, Department of Economics and Finance.
    6. Minguez-Afonso, Gara, 2006. "Imperfect common knowledge in first generation models of currency crises," LSE Research Online Documents on Economics 24509, London School of Economics and Political Science, LSE Library.

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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