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Endogenous crashes in the foreign exchange market: a theoretical model

Louis Raffestin ()

Finance, 2019, vol. 40, issue 1, 7-51

Abstract: We present a model of the foreign exchange market in which cash-constrained carry traders trade with short-sighted, boundedly rational chartists. This simple market structure provides a theoretical basis for the fact that the currencies of high interest rate countries tend to crash, sometimes without a fundamental trigger. Crash risk comes from a perverse interaction between carry traders and chartists, and is maximized when both investors are very active in the market.

Keywords: currency crashes; chartists; carry traders; funding constraints; rational expectations (search for similar items in EconPapers)
Date: 2019
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