Self-Fulfilling Risk Predictions: An Application to Speculative Attacks

August 1, 1998

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Format: Chicago

Robert P Flood, and Nancy P. Marion Self-Fulfilling Risk Predictions: An Application to Speculative Attacks, (USA: International Monetary Fund, 1998) accessed December 26, 2024

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.

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

Keywords: Asia and Pacific, Conventional peg, Currency crisis, Devaluation, Europe, Exchange rate float, Exchange rates, Exchange-rate variance, International reserves, Market structure, Mexico, Monetary base, Money demand, Price level, Return on investment, Risk premium, Shadow exchange rate, Shadow rate, U.S. dollar, WP

Publication Details

Pages:

34
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 1998/124
Stock No:

WPIEA1241998
ISBN:

9781451854695
ISSN:

1018-5941

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