Currency Crises and the Term Structure of Interest Rates

Abstract

The currency crisis literature has identified two possible types of crisis: fundamentals based crises and self-fulfilling crises. A fundamentals based crisis arises when some state variable, such as foreign exchange reserves, reaches a critical level and triggers the abandonment of the fixed rate. A self-fulfilling crisis is triggered by an autonomous change in the beliefs of speculators. This paper demonstrates how these two types of crises generate different behaviour in the term structure in the period before the crisis.