Currency Crisis Triggers: Sunspots or Thresholds?

33 Pages Posted: 2 Jun 2008

See all articles by Bernardo Guimarães

Bernardo Guimarães

London School of Economics & Political Science (LSE) - Department of Economics

Date Written: September 2007

Abstract

If currency crises are triggered when the currency overvaluation hits a threshold, the expected magnitude of a devaluation, conditional on its occurrence, is substantially different from the unconditional expected currency overvaluation. That is not true if currency crises are triggered by sunspots. Therefore, implications for the behaviour of the probability and the expected magnitude of a devaluation depend on what triggers currency crises. Those two variables are not observable but can be estimated using data on exchange rate options. This paper identifies the probability and expected magnitude of a devaluation of Brazilian Real in the period leading up to the end of the Brazilian pegged exchange rate regime and contrasts the estimates to the predictions from a simple model of currency crises under different assumptions about the trigger. The empirical findings favour thresholds and learning over sunspots.

Keywords: currency crises, exchange rate, options, sunspots

JEL Classification: F3, G1

Suggested Citation

Guimarães, Bernardo, Currency Crisis Triggers: Sunspots or Thresholds? (September 2007). CEPR Discussion Paper No. DP6487, Available at SSRN: https://ssrn.com/abstract=1138951

Bernardo Guimarães (Contact Author)

London School of Economics & Political Science (LSE) - Department of Economics ( email )

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+44 (0)20 7955 7502 (Phone)

HOME PAGE: http://personal.lse.ac.uk/guimarae

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