Self-Fulfilling Risk Predictions [electronic resource] : An Application to Speculative Attacks / Robert P Flood.
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TextSeries: IMF Working Papers; Working Paper ; No. 98/124Publication details: Washington, D.C. : International Monetary Fund, 1998Description: 1 online resource (34 p.)ISBN: 1451854692 :ISSN: 1018-5941Subject(s): Bond | Currency Crisis | Devaluation | Exchange Rate | Fixed Exchange Rate | International Reserves | MexicoAdditional physical formats: Print Version:: Self-Fulfilling Risk Predictions : An Application to Speculative AttacksOnline resources: IMF e-Library | IMF Book Store Abstract: 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.
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.
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