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Loss of confidence and currency crises

Author

Listed:
  • Spanjers, Willem

    (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.

Suggested Citation

  • Spanjers, Willem, 2005. "Loss of confidence and currency crises," Economics Discussion Papers 2005-2, School of Economics, Kingston University London.
    • Handle: RePEc:ris:kngedp:2005_002
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    Cited by:

    1. Ghatak, Subrata & Spanjers, Willem, 2007. "Monetary policy rules in transition economies: the impact of ambiguity," Economics Discussion Papers 2007-2, School of Economics, Kingston University London.

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    More about this item

    Keywords

    Fixed Exchange Rates; Currency Crises; Ambiguity; Choquet Expected Utility; Euro area; Central and Eastern Europe;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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