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A Twin Crisis Model Inspired by the Asian Crisis

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  • Irina Bunda

    () (LEO - Laboratoire d'économie d'Orleans - UO - Université d'Orléans - CNRS - Centre National de la Recherche Scientifique)

Abstract

In this paper, we propose a twin crises synthetic model. We show that there may be multiple equilibria on the exchange market as well as on the international financial one and emphasize the possible connections between currency and financial crises. On the exchange market, the currency devaluation is the outcome of a trade-off by the government in presence of implicit safety nets of the banking sector. The crisis occurs whenever the anticipated devaluation rate by the market is equal to the "optimal" devaluation rate of the government. As far as the international financial market is concerned, the passage from one equilibrium to another is triggered by the evolution of the ratio Currency Reserves/Short Term Debt as a fundamental factor. Combining bank run dynamics and fundamental factors, we aim at reconciling the two major interpretations of currency and banking crises, namely the fragility of emerging financial systems and the ex-post worsening of domestic fundamentals originating in debtors or domestic government moral hazard.

Suggested Citation

  • Irina Bunda, 2006. "A Twin Crisis Model Inspired by the Asian Crisis," Working Papers hal-00422507, HAL.
  • Handle: RePEc:hal:wpaper:hal-00422507
    Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-00422507
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    References listed on IDEAS

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    1. Robert Dekle & Kenneth Kletzer, 2002. "Domestic Bank Regulation and Financial Crises: Theory and Empirical Evidence from East Asia," NBER Chapters,in: Preventing Currency Crises in Emerging Markets, pages 507-558 National Bureau of Economic Research, Inc.
    2. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
    3. Martin Schneider & Aaron Tornell, 2004. "Balance Sheet Effects, Bailout Guarantees and Financial Crises," Review of Economic Studies, Oxford University Press, vol. 71(3), pages 883-913.
    4. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "Paper tigers?: A model of the Asian crisis," European Economic Review, Elsevier, vol. 43(7), pages 1211-1236, June.
    5. Bris, Arturo & Koskinen, Yrjo, 2002. "Corporate leverage and currency crises," Journal of Financial Economics, Elsevier, vol. 63(2), pages 275-310, February.
    6. Chang, Roberto & Velasco, Andres, 2000. "Financial Fragility and the Exchange Rate Regime," Journal of Economic Theory, Elsevier, vol. 92(1), pages 1-34, May.
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