Currency Crises: Strategic Game between Central Bank and Spot Speculators

Imperial College Management School Discussion Paper No. SWP9814/F

23 Pages Posted: 3 Jul 2009

See all articles by Aleš Černý

Aleš Černý

Cass Business School, City, University of London

Date Written: March 1, 2000

Abstract

The paper studies an optimal switching policy between fixed and floating exchange rate regimes when the central bank dislikes losing reserves. We show that the optimal central bank intervention rule is not fully transparent in that the central bank will choose to randomize the devaluation over a range of the shadow exchange rate values to prevent a massive loss of reserves at one point in time. As a result, the collapse of the exchange rate becomes unpredictable even under perfect information and common knowledge. However, unlike in models with multiple equilibria we can determine the probability of the collapse within our model. The collapse probability is endogenously determined from the interaction between the central bank and the speculators as a unique function of the shadow exchange rate. The model is therefore able to predict how unpredictable the currency devaluation is.

Keywords: speculative attack, fixed exchange rate, optimal regime switch, reserves, spot speculation, constructive ambiguity

JEL Classification: F31, E58, G11

Suggested Citation

Černý, Aleš, Currency Crises: Strategic Game between Central Bank and Spot Speculators (March 1, 2000). Imperial College Management School Discussion Paper No. SWP9814/F. Available at SSRN: https://ssrn.com/abstract=1428928 or http://dx.doi.org/10.2139/ssrn.1428928

Aleš Černý (Contact Author)

Cass Business School, City, University of London ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

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