Working Paper: CEPR ID: DP2610
Authors: Giancarlo Corsetti; Amil Dasgupta; Stephen Morris; Hyun Song Shin
Abstract: Do large investors increase the vulnerability of a country to speculative attacks in the foreign exchange markets? To address this issue, we build a model of currency crises where a single large investor and a continuum of small investors independently decide whether to attack a currency based on their private information about fundamentals. Even abstracting from signalling, the presence of the large investor does make all other traders more aggressive in their selling. Relative to the case in which there are no large investors, small investors attack the currency when fundamentals are stronger. Yet, the difference can be small, or null, depending on the relative precision of private information of the small and large investors. Adding signalling makes the influence of the large trader on small traders' behaviour much stronger.
Keywords: currency crises; herding; large traders; self-fulfilling beliefs; unique equilibrium
JEL Codes: C70; D82; F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Presence of a large trader (D41) | Incidence of speculative attacks on a currency peg (F31) |
| Presence of a large trader (D41) | Behavior of small traders (G41) |
| Behavior of small traders (G41) | Aggressiveness in attacking the currency (F31) |
| Presence of a large trader (D41) | Market fragility (E44) |
| Public disclosure of large trader's position (G18) | Effect on small traders (F69) |
| Presence of a large trader (less informed) (G14) | Diminished influence on small traders (F69) |