Working Paper: CEPR ID: DP1990
Authors: Olivier Jeanne; Paul Masson
Abstract: This paper investigates the theoretical properties of a class of 'second generation' models of currency crises as well as their applicability to empirical work. We show that under some conditions these models give rise to an arbitrarily large number of equilibria, as well as cyclic or chaotic dynamics for the devaluation expectations. We then propose an econometric technique, based on the Markov-switching regimes framework, by which these models can be brought to the data. We illustrate this empirical approach by studying the experience of the French franc between 1987 and 1993, and find that the model performs significantly better when it allows the devaluation expectations to be influenced by sunspots.
Keywords: currency crises; self-fulfilling speculation; sunspots; markov switching regimes; european monetary system; french franc
JEL Codes: F3; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| devaluation expectations (F31) | policymakers' decisions (D78) |
| high devaluation expectations (F31) | cost of maintaining fixed exchange rate system (F31) |
| devaluation expectations (F31) | collapse of fixed peg (F31) |
| sunspots (E32) | market sentiment (G10) |
| market sentiment (G10) | economic outcomes (F61) |
| economic fundamentals (E25) | devaluation expectations (F31) |
| speculator behavior (D84) | economic fundamentals (E25) |