Endogenous crashes in the foreign exchange market: a theoretical model

Louis Raffestin ()
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Louis Raffestin: LEO - Laboratoire d'Économie d'Orleans [UMR7322] - UO - Université d'Orléans - UT - Université de Tours - CNRS - Centre National de la Recherche Scientifique

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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.

Date: 2019
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Published in Finance, 2019, 40 (1), pp.7-51

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02321179

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