Working Paper: CEPR ID: DP2025
Authors: Stephen Morris; Hyun Song Shin
Abstract: The swiftness and devastating impact of recent financial crises have taken many market participants by surprise and pose challenges for economists seeking a theory of the onset of a crisis. We propose such a theory based on two features. The actions of diverse economic actors which undermine the currency are mutually reinforcing, while the fragmented nature of the media create small disparities in their information. In such circumstances, the beliefs of market participants can be tracked in the same way as the economic fundamentals and an attack is triggered when the economic fundamentals deteriorate sufficiently to fall below the minimum level of market confidence necessary to support the currency. We give a characterization of such a minimum level of confidence.
Keywords: currency crisis; common knowledge
JEL Codes: D82; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| actions of hedge funds (G23) | actions of domestic borrowers (G51) |
| deterioration of economic fundamentals (F44) | loss of confidence among market participants (E44) |
| loss of confidence among market participants (E44) | currency attack (F31) |
| deterioration of economic fundamentals (F44) | currency attack (F31) |