Self-Fulfilling Risk Predictions: An Application to Speculative Attacks

Author/Editor:

Robert P Flood ; Nancy P. Marion

Publication Date:

August 1, 1998

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

The paper shows that changing market beliefs about currency risk can generate a self-fulfilling speculative attack on a fixed exchange rate. The attack does not require a later change in policies to make it profitable. This is illustrated by introducing an endogenous risk premium into a “first-generation model” of a speculative attack. The model is further modified to take account of sterilization, debt-financed fiscal deficits, and anticipatory price-setting behavior. The model is used to interpret the 1994 Mexican peso crisis.

Series:

Working Paper No. 1998/124

Subject:

Central banks Conventional peg Exchange rates Foreign exchange International reserves Monetary base Money National accounts Return on investment

English

Publication Date:

August 1, 1998

ISBN/ISSN:

9781451854695/1018-5941

Stock No:

WPIEA1241998

Pages:

34

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