A Model of Contagious Currency Crises with Application to Argentina
March 1, 1999
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Summary
This paper proposes a model of contagious currency crises: crises transmit across countries by raising the risk premium on government bonds. Three types of equilibria can occur: a “no-collapse” equilibrium (crises never transmit from abroad); a “collapse” equilibrium (crises are inevitably contagious); or a “fundamentals” equilibrium (crises are contagious if domestic fundamentals are weak). A calibration exercise finds that the 1995 turmoil in Argentina coexisted with a combination of risk-averse investors and weak credibility in the currency board arrangement. This turmoil could only be attributed to a Tequila effect from the Mexican crisis alone if investors were excessively risk-averse.
Subject: Conventional peg, Exchange rate arrangements, Exchange rates, Floating exchange rates, Foreign exchange, National accounts, Return on investment
Keywords: Argentina, Argentina's economy, Asia and Pacific, contagion, contagion effect, Conventional peg, crisis in Mexico, degree of risk aversion, exchange rate, Exchange rate arrangements, exchange rate crisis, exchange rate peg, Exchange rates, fixed exchange rate system, Floating exchange rates, investors' degree, multiple equilibria, Return on investment, risk aversion, WP
Pages:
26
Volume:
1999
DOI:
Issue:
029
Series:
Working Paper No. 1999/029
Stock No:
WPIEA0291999
ISBN:
9781451844788
ISSN:
1018-5941
