Currency Attacks Research Articles

Investigating the feasibility of the double-play strategy: evidence from Hong Kong’s speculative attacks

ABSTRACT This paper examines the ‘double-play’ strategy adopted by speculators during currency attacks in Hong Kong. We modify the speculators’ objective function to interpret how they earned potential returns from the automatic mechanism of the linked exchange rate system. Furthermore, we investigate the dynamic conditional correlations among currency, stock and derivatives markets, and identify the key determinants for these relationships during speculative attacks. Our findings offer a comprehensive insight into the behaviour of speculators during currency attacks, and provide compelling empirical support for the impact of central bank interventions on market dynamics.

Dynamic effects of trade barriers with speculation on foreign currency: The case of Iran

This paper presents a small open economy, dynamic general equilibrium model with cash-in advance constraint and a currency attack to explain the dynamic effects of changes in trade barriers in the short and long run. The model is calibrated using data on macroeconomic variables in Iran's economy from 1990 to 2013 to identify and analyze the effects of barriers imposed on trade. We analyze the effects of counterfactual fiscal, monetary and exchange rate policies in response to trade barriers and show how the economy would respond in different time horizons. We also evaluate the effects of eliminating each of the factors causing this stagflation. Our findings show that the short-term drop in non-oil production is mostly due to the decline in total productivity and not trade barriers. On the other hand, barriers imposed on the trade of oil and non-oil goods had a considerable impact on the decline in non-oil production in the medium and long run, as well as the fall in total income. Finally, we show that the news of trade barrier imposition has a considerable impact on the impulse to speculate, giving rise to a likely currency crisis and devaluation that have a substantial effect on inflation and real output.

Endogenous corporate leverage response to a safer macro environment: The case of foreign exchange reserve accumulation

A country may adopt policy measures such as raising its foreign exchange reserves to better prepare for sudden reversal of international capital flows or currency attacks, which in principle should reduce financial vulnerability for its firms and the entire economy, but the beneficial effect of such policies may be partially offset by endogenous firms' decisions to take on more risks. We present a robust but previously undocumented relationship between corporate leverage and country-level foreign exchange reserve holdings. For 6610 non-financial firms in 23 emerging markets from 2000 to 2006, we show that more foreign reserve accumulation leads to higher corporate leverage. The effect is significantly greater in sectors that are intrinsically more sensitive to uncertainty. We go from correlation to causality via a two-prong instrumental variable strategy: simultaneously (1) instrumenting FX reserves by global commodity price movement, and (2) examining leverage of firms outside the commodity-sensitive sectors.

Large Traders, Asset Markets, and Currency Crises

During currency crises, large traders once simultaneously short the asset markets and currency market. We study the large trader's information manipulation in crises by introducing a large trader in an asset market and a currency-attack coordination game with imperfect information. The asset price realized in the asset market aggregates dispersed private information acting as a public signal in the currency attack game. We show that the incentive of the large trader to manipulate the asset price in favor of its currency attack leads to the financial contagion. In equilibrium, the large trader's manipulating the asset price to be lower and attacking the currency regime are concurrent; the large trader's manipulation in the asset market is most significant when the public signal is in the intermediate range. To draw policy implication regarding the market transparency, we show that when the asset market is transparent, a natural equilibrium refinement that incorporates forward induction reasoning would select the equilibrium where every trader behaves most aggressively in the currency-attack game and the currency regime is most fragile.

Competing to Coordinate: Crowding Out in Coordination Games

This paper develops a framework for coordination games that accounts for the role of competition. When crowding out is severe, agents no longer find it optimal to coordinate when everyone else participates. Our setup allows for the characterization of equilibrium outcomes when payoffs are subject to any degree of crowding out and presents a set of comparative statics with respect to the substitutability feature. The model highlights the impact of competition in coordination games, wherein substitutability lowers individual payoffs from coordinating. In many common global game contexts, accounting for the crowding out of payoffs changes widely held intuitions on strategies and on policy implications. For example, in the context of speculative currency attacks, selling a currency after receiving a sufficiently bad signal about reserves may no longer be a dominant strategy; in the presence of substitutability, setting a quota on how many speculators can attack may increase the chance of abandoning the peg; currencies with potentially small depreciation but ample liquidity can be subject to more pressure than currencies with potentially large depreciation but low liquidity.

Coordination in Global Games with Heterogeneous Agents

This paper studies equilibrium selection in large coordination games played by heterogeneous agents, such as models of bank runs, currency attacks or technology adoption. Player payoffs are affected by the average action and the player’s type, as well as a global parameter reflecting economic fundamentals. I introduce the notion of ex ante risk dominance and show that it coincides with the global games selection in games with payoffs that are separable in average action and type. Ex ante risk dominance provides an economic interpretation behind the global games selection in terms of maximizing ex ante expected payoffs under pessimistic beliefs. I characterize the ex ante risk dominant equilibrium, pinning down the presence of tipping points in terms of economic fundamentals. I also show that payoff separability is needed for the global games selection to be uniform, that is, to be robust to changes in the distribution of signal noise.

Strategic Uncertainty in the Guessing Game and the Role and Effects of a Public Common Noise Player

Guessing games are often used in the behavioral economics literature to investigate the rationality of economic agents. In this paper, the author uses a typical guessing game to examine not only the rationality of the test subjects but also the degree of their strategic uncertainty in playing the guessing game. A typically negative relationship was found between the frequency and the degree of strategic uncertainty, measured by proxy using the test subjects' guesses as to the standard deviation of all test subjects' answers regarding selection of a number from a specified interval. The role and effects of a public common noise player in the guessing game were investigated, which showed that the existence of such a player, even when he/she is not rational, can decrease the variance of the answered values and the degree of strategic uncertainty. These findings imply that the existence of a public common noisy player who is not necessarily rational can provide an anchoring focal point in the guessing game under uncertainty and that this player can be an influential coordinator. This implication would be useful in explaining possible bubbles or booms/bursts, collective short sales such as currency attacks in markets, or other real-world economic and business anomalies.

Economic costs of alternative monetary policy responses to speculative currency attacks

The outcome of a speculative attack on the foreign exchange rate can be classified into three cases: (i) immediate depreciation of the nominal exchange rate, (ii) successful defense, or (iii) failed defense. This paper explores which of these outcomes yields the lowest cost in terms of output and unemployment in the short and medium run. Ex-ante the outcome of a speculative attack is uncertain, therefore the appropriate response of monetary authorities to a speculative attack depends on the cost of an immediate depreciation compared with that of the expected outcome of a currency defense. Our empirical analysis focuses on a sample of 73 emerging and developing countries over the 1960–2011 period. Our results indicate that an immediate depreciation is the policy response that is associated with a lower expected output loss and unemployment in the short run and it tends to be expansionary in the medium run. A defense, if successful, entails insignificant costs in the short run but, unlike an immediate depreciation, a successful defense is not expansionary in the medium run. If a defense fails, large output losses and an increase in unemployment ensue, at least in the short run.

Economic Costs of Alternative Monetary Policy Responses to Speculative Currency Attacks

The outcome of a speculative attack on the foreign exchange rate can be classified into three cases: (i) immediate depreciation of the nominal exchange rate, (ii) successful defense, or (iii) failed defense. This paper explores which of these outcomes yields the lowest cost in terms of output and unemployment in the short and medium run. Ex-ante the outcome of a speculative attack is uncertain, therefore the appropriate response of monetary authorities to a speculative attack depends on the cost of an immediate depreciation compared with that of the expected outcome of a currency defense. Our empirical analysis focuses on a sample of 73 emerging and developing countries over the 1960-2011 period. Our results indicate that an immediate depreciation is the policy response that is associated with a lower expected output loss and unemployment in the short run and it tends to be expansionary in the medium run. A defense, if successful, entails insignificant costs in the short run but, unlike an immediate depreciation, a successful defense is not expansionary in the medium run. If a defense fails, large output losses and an increase in unemployment ensue, at least in the short run.

Falling Dominoes: A Theory of Rare Events and Crisis Contagion

Crises, such as revolutions and currency attacks, rarely occur; but when they do they typically arrive in waves. The rarity of crises is an important contagion mechanism in a multiple-country dynamic global game model. When players are uncertain about the true model of the world, observing a rare success elsewhere can substantially change their expectations concerning the payoffs from attacking or defending the regime. Such dramatic revisions in beliefs, amplified by strategic complementarity in actions, may lead to a series of attacks in other countries. The crisis period can be long-lasting, but will eventually come to an end. (JEL D74, D83, F33, G01)

Coordination under limited depth of reasoning

This paper provides the first unified explanation of behavior in coordinated attack games under both public and private information. It demonstrates that the main experimental results, such as threshold strategies, comparative statics, and the differences in behavior under public and private information, are robust predictions of limited depth of reasoning models. This is in contrast to equilibrium, which mispredicts the coordinating roles of public and private information. The analysis has implications for understanding macroeconomic phenomena, like currency attacks and debt crises, which are commonly modeled using incomplete information coordinated attack games.

Regulations on direct investment in ASEAN: do they reduce currency instability?

Many authors have studied the impact of capital controls on currency crises. However, few attempts have been made to explore the impact of separate controls on each type of capital flow on currency instability. To date, no study has examined the impact of regulation and control of direct investment on the probability of currency instability. The hypothesis of this study is that direct investment control decreases currency instability, especially when there is no control over the liquidation of direct investment. Regression analysis of probit panel data from eight ASEAN members over 1998–2011 supported this hypothesis. Another interesting outcome, which confirms the results of previous studies, is that overall capital control insufficiently protects countries against currency attacks. This study underlines the importance of considering various types of capital flows separately during external reform policy in emerging economies.

Playing with Fire: Pre-Electoral Fiscal Manipulation and the Risk of a Speculative Attack

Conventional wisdom holds that voters in developing countries fail to punish pervasive pre-electoral fiscal manipulation. However, we argue that governments are unlikely to engage in pre-electoral fiscal manipulation when facing a high risk of speculative currency attacks. In particular, under fixed exchange rates, governments are less likely to engage in fiscal electioneering when either their real exchange rate is highly appreciated or their foreign exchange reserves are low. In contrast, under a flexible exchange rate, neither a country's real exchange rate nor its reserves affects governments' decision to engage in fiscal manipulation. Our argument receives support through a quantitative analysis of government budget balances in 97 developing countries from 1975 to 2005.

The role of a large trader in a dynamic currency attack model

Abstract This paper studies the role of a large trader in a dynamic currency attack model based on Abreu and Brunnermeier (2003), who study stock market bubbles and crashes in a dynamic model with a continuum of rational small traders. We introduce a large trader into their model and apply it to currency attacks. In an attack against a fixed exchange rate regime with a gradually overvalued currency, traders lack common knowledge about the time when the overvaluation starts and need to coordinate to break a peg. Both the inability of traders to synchronize their attack and their incentive to time the collapse of the regime lead to the persistent overvaluation of the currency. We find that the presence of a large trader with perfect information induces small traders to attack sooner and leads to an accelerated collapse of the regime. But the presence of a large trader with noisy information may delay the collapse of the regime ex post. Moreover, a large trader with precise information tends to be at the rear of an attack. With noisy information, he could attack earlier or later than small traders. In both cases, the large trader affects market dynamics of the attack substantially.

Coordination with local information

How can the details of who observes what affect the outcomes of economic, social, and political interactions? Our thesis is that outcomes do not depend merely on the status quo and the available (noisy) information on it; they also crucially depend on how the available pieces of information are allocated among strategic agents. We study the dependence of coordination outcomes on local information sharing. In the economic literature, common knowledge of the fundamentals leads to the standard case of multiple equilibria due to the self-fullling nature of agents' beliefs. The global-games framework has been used extensively as a toolkit for arriving at a unique equilibrium selection in the context of coordination games, which can model bank runs, currency attacks, and social uprisings, among others. Yet, there is a natural mechanism through which multiplicity can reemerge, while keeping information solely exogenous: the (exogenous) information structure per se, namely, the details of who observes what noisy observation. The aim of this paper is to understand the role of the exogenous information structure in the determination and characterization of equilibria in the coordination game. We answer the question of how the equilibria of the coordination game depend on the details of local information sharing. Our main contribution is to provide conditions for uniqueness and multiplicity that pertain solely to the details of information sharing. The findings in the present paper give an immediate answer as to the determinacy of equilibria using only the characterization of what agent observes what pieces of information. We build on the standard global game framework for coordination games with incomplete and asymmetric information and consider a coordination game in which each of a collection of agents decides whether to take a risky action (whose payoff depends on how many agents made the same decision, and the fundamentals) or a safe action, based on their noisy observations regarding the fundamentals. Generalizing away from the standard practice of considering only private and public signals, we allow for signals that are observed by arbitrary subsets of the agents. We refer to signals that are neither private nor public as local signals. We pose the following question: how do the equilibria of the coordination game depend on the information locality, i.e., on the details of local information sharing. Our key finding is that the number of equilibria is highly sensitive to the details of information locality. As a result, a new dimension of indeterminacy regarding the outcomes is being introduced: not only may the same fundamentals well lead to different outcomes in different societies, due to different realizations of the noisy observations; the novel message of this work is that the same realization of the noisy observations is compatible with different equilibrium outcomes in societies with different structures of local information sharing. In particular, we show that as long as a collection of agents share the same observations, and no other agent's observations overlap with their common observations, multiple equilibria arise. Identical observations is not, nevertheless, a necessary condition for multiplicity: we show that as long as the observations of a collection of agents form a cascade of containments, and no other agent's observations overlap with the observations of the collection, then multiplicity emerges. This is not to say however that common knowledge of information at the local level necessarily implies multiplicity: in particular, in the absence of identical observations or cascade of containments of observations, or if the condition of no overlap of information is violated, then, despite the presence of some signals that are common knowledge between agents, a unique equilibrium may be selected. In the case where each agent observes exactly one signal, we characterize the set of equilibria as a function of the details of the information structure. We show how the distance between the largest and smallest equilibria depends on how information is locally shared among the agents. In particular, the more equalized the sizes of the sets of agents who observe the same signal, the more diverse the information of each group becomes, heightening inter-group strategic uncertainty, and leading to a more refined set of equilibria. We use our characterization to study the set of equilibria in large coordination games. We show that as the number of agents grows, the game exhibits a unique equilibrium if and only if the largest set of agents with access to a common signal grows sublinearly in the number of agents, thus identifying a sharp threshold for uniqueness versus multiplicity.

Estimating Extensive Form Games inR

This article introduces new software, the games package, for estimating strategic statistical models in R. In these models, the probability distribution over outcomes corresponds to the equilibrium of an underlying game form. We review such models and provide derivations for one example, including discussion of alternative motivations for the stochastic component of the models. We introduce the basic functionality of the games package, such as how to estimate players’ utilities for outcomes as a function of covariates. The package implements maximum likelihood estimation for the most commonly used models of strategic choice, including three extensive form games and an ultimatum bargaining model. The software also includes functions for bootstrapping, plotting fitted values with their confidence intervals, performing non-nested model comparisons, and checking global convergence failures. We use the new software to replicate Leblang’s (2003) analysis of speculative currency attacks.

Selection-free predictions in global games with endogenous information and multiple equilibria

Global games with endogenous information often exhibit multiple equilibria. In this paper, we show how one can nevertheless identify useful predictions that are robust across all equilibria and that cannot be delivered in the commonknowledge counterparts of these games. Our analysis is conducted within a flexible family of games of regime change, which have been used to model, inter alia, speculative currency attacks, debt crises, and political change. The endogeneity of information originates in the signaling role of policy choices. A novel procedure of iterated elimination of nonequilibrium strategies is used to deliver probabilistic predictions that an outside observer—an econometrician—can form under arbitrary equilibrium selections. The sharpness of these predictions improves as the noise gets smaller, but disappears in the complete-information version of the

Coordination and learning in dynamic global games: experimental evidence

Coordination problems are ubiquitous in social and economic life. Political mass demonstrations, the decision whether to join a speculative currency attack, investment in a risky venture, and capital flight from a particular country are all characterized by coordination problems. Furthermore, all these events have a dynamic nature which has been largely omitted from previous experimental studies. Here I use a two-stage variant of a dynamic global game to study experimentally how the arrival of information in a dynamic setting affects the relative aggressiveness of speculators. In the first stage, subjects exhibit excess aggressiveness, which appears to be driven by beliefs about others’ actions rather than an intrinsic taste for attacking. However, following a failed first-stage attack, subjects learn to be less aggressive in the second stage. On the other hand, the arrival of new, more precise information after a failed attack leads to an increase in subjects’ aggressiveness. Beliefs, again, play a crucial role in explaining how the arrival of information affects attacking behavior.

Rationalizability in games with a continuum of players

The concept of rationalizability has been used in the last fifteen years to study stability of equilibria in models with a continuum of agents such as competitive markets, macroeconomic dynamics and currency attacks. However, rationalizability has been formally defined in general settings only for games with a finite number of players. We propose an exploration of rationalizability in the context of games with a continuum of players. We deal with a special class of these games, in which payoff of each player depends only on his own strategy and on an aggregate value: the state of the game, which is obtained from the complete action profile. We define the sets of point-rationalizable states and rationalizable states. For the case of continuous payoffs and compact strategy sets, we characterize these sets and prove their convexity and compactness. We provide as well results on the equivalence of point- and standard-rationalizability.

Learning and Complementarities in Speculative Attacks

We study a model where the aggregate trading of currency speculators reveals new information to the central bank and affects its policy decision. We show that the learning process gives rise to coordination motives among speculators leading to large currency attacks and introducing non-fundamental volatility into exchange rates and policy decisions. We show that the central bank can improve the ex ante effectiveness of its policy by committing to put a lower weight ex post on the information from the market, and that transparency may either increase or decrease the effectiveness of learning from the market, depending on how it is implemented.