IDEAS home Printed from https://ideas.repec.org/p/fip/fednsr/249.html
   My bibliography  Save this paper

Expectations and contagion in self-fulfilling currency attacks

Author

Listed:
  • Todd Keister

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.

Suggested Citation

  • Todd Keister, 2006. "Expectations and contagion in self-fulfilling currency attacks," Staff Reports 249, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:249
    as

    Download full text from publisher

    File URL: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr249.html
    Download Restriction: no
    File URL: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr249.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. John C. Harsanyi & Reinhard Selten, 1988. "A General Theory of Equilibrium Selection in Games," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262582384, December.
    2. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-597, June.
    3. Carlsson, Hans & van Damme, Eric, 1993. "Global Games and Equilibrium Selection," Econometrica, Econometric Society, vol. 61(5), pages 989-1018, September.
    4. Guimaraes, Bernardo & Morris, Stephen, 2007. "Risk and wealth in a model of self-fulfilling currency attacks," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2205-2230, November.
    5. Franklin Allen & Douglas Gale, 2000. "Financial Contagion," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 1-33, February.
    6. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June.
    7. Glick,Reuven & Moreno,Ramon & Spiegel,Mark M. (ed.), 2001. "Financial Crises in Emerging Markets," Cambridge Books, Cambridge University Press, number 9780521800204, November.
    8. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1996. "Contagious Currency Crises," NBER Working Papers 5681, National Bureau of Economic Research, Inc.
    9. Reuven Glick & Ramon Moreno & Mark M. Spiegel, 2001. "Financial crises in emerging markets," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue mar.23.
    10. Goldstein, Itay & Pauzner, Ady, 2004. "Contagion of self-fulfilling financial crises due to diversification of investment portfolios," Journal of Economic Theory, Elsevier, vol. 119(1), pages 151-183, November.
    11. Glick, Reuven & Rose, Andrew K., 1999. "Contagion and trade: Why are currency crises regional?," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 603-617, August.
    12. Cass, David & Shell, Karl, 1983. "Do Sunspots Matter?," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 193-227, April.
    13. Laura E. Kodres & Matthew Pritsker, 2002. "A Rational Expectations Model of Financial Contagion," Journal of Finance, American Finance Association, vol. 57(2), pages 769-799, April.
    14. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, vol. 40(3-5), pages 1037-1047, April.
    15. Spear, Stephen E, 1989. "Are Sunspots Necessary?," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 965-973, August.
    16. Paul R. Masson, 1999. "Multiple equilibria, contagion, and the emerging market crises," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
    17. Dornbusch, Rudiger & Park, Yung Chul & Claessens, Stijn, 2000. "Contagion: Understanding How It Spreads," The World Bank Research Observer, World Bank, vol. 15(2), pages 177-197, August.
    18. Van Rijckeghem, Caroline & Weder, Beatrice, 2001. "Sources of contagion: is it finance or trade?," Journal of International Economics, Elsevier, vol. 54(2), pages 293-308, August.
    19. Frank Heinemann, 2000. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks: Comment," American Economic Review, American Economic Association, vol. 90(1), pages 316-318, March.
    20. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 1, pages 35-54, November.
    21. Christian Hellwig & Laura Veldkamp, 2009. "Knowing What Others Know: Coordination Motives in Information Acquisition," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 76(1), pages 223-251.
    22. Amil Dasgupta, 2004. "Financial Contagion Through Capital Connections: A Model of the Origin and Spread of Bank Panics," Journal of the European Economic Association, MIT Press, vol. 2(6), pages 1049-1084, December.
    23. Heinemann, Frank & Illing, Gerhard, 2002. "Speculative attacks: unique equilibrium and transparency," Journal of International Economics, Elsevier, vol. 58(2), pages 429-450, December.
    24. Eichengreen, Barry & Rose, Andrew & Wyplosz, Charles, 1996. " Contagious Currency Crises: First Tests," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(4), pages 463-484, December.
    25. Gerlach, Stefan & Smets, Frank, 1995. "Contagious speculative attacks," European Journal of Political Economy, Elsevier, vol. 11(1), pages 45-63, March.
    26. Ennis, Huberto M. & Keister, Todd, 2005. "Government policy and the probability of coordination failures," European Economic Review, Elsevier, vol. 49(4), pages 939-973, May.
    27. Masson, Paul, 1999. "Contagion:: macroeconomic models with multiple equilibria," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 587-602, August.
    28. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 459-472, November.
    29. Huberto M. Ennis, 2003. "Economic fundamentals and bank runs," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 89(Spr), pages 55-71.
    30. Ennis, Huberto M. & Keister, Todd, 2005. "Optimal fiscal policy under multiple equilibria," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1359-1377, November.
    31. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Junichi Fujimoto, 2014. "Speculative attacks with multiple targets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 57(1), pages 89-132, September.
    2. Tamgac, Unay, 2011. "Crisis and self-fulfilling expectations: The Turkish experience in 1994 and 2000-2001," International Review of Economics & Finance, Elsevier, vol. 20(1), pages 44-58, January.
    3. Agata Kliber, 2011. "Sovereign CDS Instruments in Central Europe – Linkages and Interdependence," Dynamic Econometric Models, Uniwersytet Mikolaja Kopernika, vol. 11, pages 111-128.
    4. Tai-kuang Ho & Ming-yen Wu, 2012. "Third-person Effect and Financial Contagion in the Context of a Global Game," Open Economies Review, Springer, vol. 23(5), pages 823-846, November.
    5. Huberto M. Ennis, 2005. "Complementariedades y Política Macroeconómica," IIE, Working Papers 054, IIE, Universidad Nacional de La Plata.
    6. Jean-Marc Tallon, 2006. "Incertitude stratégique et sélection d'équilibre : deux applications," Revue d'économie industrielle, De Boeck Université, vol. 0(2), pages 6-6.
    7. Dzsamila Vonnak, 2018. "Multidimensional global games and some applications," CERS-IE WORKING PAPERS 1803, Institute of Economics, Centre for Economic and Regional Studies.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Piersanti, Giovanni, 2012. "The Macroeconomic Theory of Exchange Rate Crises," OUP Catalogue, Oxford University Press, number 9780199653126.
    2. Goldstein, Itay & Razin, Assaf, 2015. "Three Branches of Theories of Financial Crises," Foundations and Trends(R) in Finance, now publishers, vol. 10(2), pages 113-180, 30.
    3. Ahnert, Toni & Bertsch, Christoph, 2013. "A wake-up call: information contagion and strategic uncertainty," Working Paper Series 282, Sveriges Riksbank (Central Bank of Sweden), revised 01 Mar 2014.
    4. Mohammad Karimi & Marcel‐Cristian Voia, 2019. "Empirics of currency crises: A duration analysis approach," Review of Financial Economics, John Wiley & Sons, vol. 37(3), pages 428-449, July.
    5. Marcel Fratzscher, 2003. "On currency crises and contagion," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 8(2), pages 109-129.
    6. Toni Ahnert & Christoph Bertsch, 2022. "A Wake-Up Call Theory of Contagion [Asymmetric business cycles: theory and time-series evidence]," Review of Finance, European Finance Association, vol. 26(4), pages 829-854.
    7. Giancarlo Marini & Giovanni Piersanti, 2012. "Models of Speculative Attacks and Crashes in International Capital Markets," CEIS Research Paper 245, Tor Vergata University, CEIS, revised 24 Jul 2012.
    8. Komulainen, Tuomas, 2001. "Currency crises in emerging markets : Capital flows and herding behaviour," BOFIT Discussion Papers 10/2001, Bank of Finland, Institute for Economies in Transition.
    9. Assaf Razin & Itay Goldstein, 2012. "Review Of Theories of Financial Crises," 2012 Meeting Papers 214, Society for Economic Dynamics.
    10. Dasgupta, Amil & Leon-Gonzalez, Roberto & Shortland, Anja, 2011. "Regionality revisited: An examination of the direction of spread of currency crises," Journal of International Money and Finance, Elsevier, vol. 30(5), pages 831-848, September.
    11. Angeletos, G.-M. & Lian, C., 2016. "Incomplete Information in Macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1065-1240, Elsevier.
    12. Mardi Dungey & Renee Fry & Brenda Gonzalez-Hermosillo & Vance Martin, 2005. "Empirical modelling of contagion: a review of methodologies," Quantitative Finance, Taylor & Francis Journals, vol. 5(1), pages 9-24.
    13. Gonzalez-Hermosillo Gonzalez, B.M., 2008. "Transmission of shocks across global financial markets : The role of contagion and investors' risk appetite," Other publications TiSEM d684f3c7-7ad8-4e93-88cf-a, Tilburg University, School of Economics and Management.
    14. Komulainen, Tuomas, 2001. "Currency crises in emerging markets: Capital flows and herding behaviour," BOFIT Discussion Papers 10/2001, Bank of Finland Institute for Emerging Economies (BOFIT).
    15. repec:zbw:bofitp:2001_010 is not listed on IDEAS
    16. Aït-Sahalia, Yacine & Cacho-Diaz, Julio & Laeven, Roger J.A., 2015. "Modeling financial contagion using mutually exciting jump processes," Journal of Financial Economics, Elsevier, vol. 117(3), pages 585-606.
    17. De Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic risk: A survey," Working Paper Series 35, European Central Bank.
    18. Boschi, Melisso & Goenka, Aditya, 2012. "Relative risk aversion and the transmission of financial crises," Journal of Economic Dynamics and Control, Elsevier, vol. 36(1), pages 85-99.
    19. Frankel, Jeffrey, 2010. "Monetary Policy in Emerging Markets," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 25, pages 1439-1520, Elsevier.
    20. Dungey, Mardi & Fry, Renee & Gonzalez-Hermosillo, Brenda & Martin, Vance, 2006. "Contagion in international bond markets during the Russian and the LTCM crises," Journal of Financial Stability, Elsevier, vol. 2(1), pages 1-27, April.
    21. Haile, Fasika & Pozo, Susan, 2008. "Currency crisis contagion and the identification of transmission channels," International Review of Economics & Finance, Elsevier, vol. 17(4), pages 572-588, October.

    More about this item

    Keywords

    Financial crises; Foreign exchange market; Devaluation of currency;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fednsr:249. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Gabriella Bucciarelli (email available below). General contact details of provider: https://edirc.repec.org/data/frbnyus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.