Expectations and contagion in self-fulfilling currency attacks

Todd Keister

No 249, Staff Reports from Federal Reserve Bank of New York

Abstract: This paper presents a model in which currency crises can spread across countries as a result of the self-fulfilling beliefs of market participants. An incomplete-information approach is used to overcome many undesirable features of existing multiple-equilibrium explanations of contagion. If speculators expect contagion across markets to occur, they have an incentive to trade in both currency markets to take advantage of this correlation. These actions, in turn, link the two markets in such a way that a sharp devaluation of one currency will be propagated to the other market, fulfilling the original expectations. Even though this contagion is driven solely by expectations, the model places restrictions on observable variables that are broadly consistent with existing empirical evidence.

Keywords: Financial crises; Foreign exchange market; Devaluation of currency (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-ifn and nep-mon
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: EXPECTATIONS AND CONTAGION IN SELF-FULFILLING CURRENCY ATTACKS (2009)
Working Paper: Expectations and Contagion in Self-fulfilling Currency Attacks (2006)
Working Paper: Expectations and Contagion in Self-Fulfilling Currency Attacks (2005)
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