Loss of confidence and currency crises

Willem Spanjers ()
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Willem Spanjers: Kingston University London

No 2005-2, Economics Discussion Papers from School of Economics, Kingston University London

Abstract: Loss of confidence is interpreted as an increase in the ambiguity experienced by investors who maximize Choquet Expected Utility. Currency crises are modelled to resemble bankruns. Using countries having fragile financial systems, a model of twin crises is obtained. An exogenous interim loss of confidence may trigger a crisis, even when the 'fundamentals' remain unchanged. Not recognizing ambiguity has a similar effect. Investors 'overreact' to bad news, as it leads to an endogenous loss of confidence. The stylized facts of the South-East Asian crisis fit the model, and it conforms well to the basic structure of the EU-accession countries in the run-up to their adoption of the Euro. Transparency, competence, and political stability, offer some protection against currency crises by increasing the level of confidence. The best protection, however, is provided by a stable financial system, as this enables share prices to absorb the impact of a loss of confidence.

Keywords: Fixed Exchange Rates; Currency Crises; Ambiguity; Choquet Expected Utility; Euro area; Central and Eastern Europe (search for similar items in EconPapers)
JEL-codes: D81 F31 F32 G20 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2005-02-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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