Imperfect Common Knowledge in First-Generation Models of Currency Crises

Gara M. Afonso ()

International Journal of Central Banking, 2007, vol. 3, issue 1, pages 81-112

Abstract: First-generation models assume that the level of reserves of a central bank is common knowledge among arbitrageurs, and therefore the timing of the attack on the currency can be correctly anticipated. The collapse of the peg thus 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 rate is abandoned. The lack of common knowledge will lead to a discrete devaluation once the peg finally collapses.

JEL-codes: D82 E58 F31 (search for similar items in EconPapers)
Date: 2007
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Related works:
Working Paper: Imperfect Common Knowledge in First Generation Models of Currency Crises (2006)
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