A Large Trader in Bubbles and Crashes: an Application to Currency Attacks
Abreu and Brunnermeier (2003) study stock market bubbles and crashes in a dynamic model with a continuum of rational small traders. We introduce a large trader into their model and apply it to currency attacks. In an attack against a fixed exchange rate regime with a gradually overvaluing currency, traders lack common knowledge about the time when the overvaluation starts. Meanwhile, they need to coordinate to break a peg. In such a setup, both the inability of traders 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 a large trader with perfect information will accelerate the collapse of the regime and alleviate currency overvaluation. However, if a large trader has incomplete information, the presence of a large trader may accelerate or delay the collapse of the regime ex post, depending on the size of his wealth and the precision of his information. More specifically, we find that a large trader with both a large amount of wealth and very noisy information can greatly delay the collapse of the regime ex post. Moreover, we find that the presence of a large trader with incomplete information can greatly increase the unpredictability about the time when the regime collapses, implying the difficulty for traders to time the collapse.
|Date of creation:||29 Jan 2010|
|Contact details of provider:|| Postal: Guelph, Ontario, N1G 2W1|
Phone: (519) 824-4120 ext. 53898
Fax: (519) 763-8497
Web page: https://www.uoguelph.ca/economics/
More information through EDIRC
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.:
- Dilip Abreu & Markus K. Brunnermeier, 2003.
"Bubbles and Crashes,"
Econometric Society, vol. 71(1), pages 173-204, January.
- Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 2002.
"The Role of Large Players in Currency Crises,"
in: Preventing Currency Crises in Emerging Markets, pages 197-268
National Bureau of Economic Research, Inc.
- Christophe Chamley, 2003. "Dynamic Speculative Attacks," American Economic Review, American Economic Association, vol. 93(3), pages 603-621, June.
- 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.
- Markus K. Brunnermeier & Stefan Nagel & Lasse H. Pedersen, 2008.
"Carry Trades and Currency Crashes,"
NBER Working Papers
14473, National Bureau of Economic Research, Inc.
When requesting a correction, please mention this item's handle: RePEc:gue:guelph:2010-04.. 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: (Stephen Kosempel)
If references are entirely missing, you can add them using this form.