Large Traders, Asset Markets, and Currency Crises

41 Pages Posted: 10 Feb 2019

See all articles by Kim-Sau Chung

Kim-Sau Chung

Hong Kong Baptist University (HKBU)

Yilin Wang

University of California, Los Angeles (UCLA) - Department of Economics

Date Written: January 29, 2019

Abstract

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.

JEL Classification: D82, D84, G12, G14

Suggested Citation

Chung, Kim-Sau and Wang, Yilin, Large Traders, Asset Markets, and Currency Crises (January 29, 2019). Available at SSRN: https://ssrn.com/abstract=3325524 or http://dx.doi.org/10.2139/ssrn.3325524

Kim-Sau Chung

Hong Kong Baptist University (HKBU) ( email )

Department of Economics
Kowloon, Hong Kong
Hong Kong

Yilin Wang (Contact Author)

University of California, Los Angeles (UCLA) - Department of Economics ( email )

8283 Bunche Hall
Los Angeles, CA 90095-1477
United States
3104478654 (Phone)

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