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A Stochastic Model of Self-Fulfilling Crises in Fixed Exchange Rate Systems

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  • Adrian, Tobias
  • Gros, Daniel

Abstract

A fixed exchange rate regime can experience a self-fulfilling crisis if a high risk premium leads to high domestic interest rates that depress domestic activity, and thus make it more likely that the government will actually abandon the system. Depending on the parameter configuration, two equilibria might exist. One is characterized by low interest rates and a low (possibly zero) probability that the exchange rate commitment will be abandoned; the other is characterized by high interest rates and a high probability that the exchange rate commitment will be abandoned. An unstable intermediate equilibrium might also exist. An increase in the uncertainty of the shocks hitting the economy reduces the parameter range in which multiple equilibria can arise. Copyright @ 1999 by John Wiley & Sons, Ltd. All rights reserved.

Suggested Citation

  • Adrian, Tobias & Gros, Daniel, 1999. "A Stochastic Model of Self-Fulfilling Crises in Fixed Exchange Rate Systems," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(2), pages 129-146, April.
    • Handle: RePEc:ijf:ijfiec:v:4:y:1999:i:2:p:129-46
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    Cited by:

    1. Daniel Gros & Carsten Hefeker, 2002. "Common Monetary Policy with Asymmetric Shocks," CESifo Working Paper Series 705, CESifo.
    2. Gros, Daniel, 2012. "A simple model of multiple equilibria and sovereign default," CEPS Papers 7174, Centre for European Policy Studies.
    3. Gros, Daniel, 2014. "The EMS Crisis of the 1990s: Parallels with the present crisis?," CEPS Papers 9119, Centre for European Policy Studies.
    4. Gros, Daniel, 2011. "Speculative Attacks within or outside a Monetary Union: Default versus Inflation (what to do today)," CEPS Papers 6359, Centre for European Policy Studies.
    5. Roberto Tamborini, 2015. "Heterogeneous Market Beliefs, Fundamentals and the Sovereign Debt Crisis in the Eurozone," Economica, London School of Economics and Political Science, vol. 82, pages 1153-1176, December.
    6. Roberto Tamborini, 2012. "Market opinions, fundamentals and the euro-sovereign debt crisis," Department of Economics Working Papers 1210, Department of Economics, University of Trento, Italia.

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