Multiple Equilibria and the Credibility of the Brazilian 'Crawling Peg', 1995-1998

28 Pages Posted: 20 May 2003

See all articles by Marco Lyrio

Marco Lyrio

Insper Institute of Education and Research

Hans Dewachter

Catholic University of Leuven (KUL) - Department of Economics; Erasmus Research Institute of Management (ERIM)

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Abstract

This paper studies the relationship between the probability of devaluation of the Brazilian real and the fundamentals of the economy for the period 1995-1998. We use a model of a fixed exchange rate system that allows for multiple equilibria and, therefore, makes possible the identification of self-fulfilling speculation. The devaluation probability is computed using the "drift adjustment method". The model performs satisfactorily in tracking monthly devaluation expectations and presents some important advantages over a simple linear regression of macroeconomic variables on the devaluation probability. We do not find evidence that self-fulfilling speculation was at work in the period preceding the Brazilian currency crisis of January 1999. This suggests that the breakdown of the Brazilian managed exchange rate system was due to the deterioration of the fundamentals of the economy.

Keywords: Currency crisis, self-fulfilling speculation, multiple equilibria, Brazilian exchange rate system

JEL Classification: F33

Suggested Citation

Lyrio, Marco and Dewachter, Hans, Multiple Equilibria and the Credibility of the Brazilian 'Crawling Peg', 1995-1998. Available at SSRN: https://ssrn.com/abstract=385886 or http://dx.doi.org/10.2139/ssrn.385886

Marco Lyrio (Contact Author)

Insper Institute of Education and Research ( email )

R Quata 300
Sao Paulo, 04542-030
Brazil

HOME PAGE: http://www.insper.edu.br/en/faculty-and-research/marco-lyrio

Hans Dewachter

Catholic University of Leuven (KUL) - Department of Economics ( email )

Center for Economic Studies
Naamsestraat 69
Leuven, B-3000
Belgium
+0032 16 326859 (Phone)
+0032 16 326796 (Fax)

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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