A Model of Contagious Currency Crises with Application to Argentina
26 Pages Posted: 12 Feb 2006
Date Written: March 1999
This paper proposes a model of contagious currency crises: crises transmit across countries by raising the risk premium on government bonds. Three types of equilibria can occur: a no-collapse equilibrium (crises never transmit from abroad); a collapse equilibrium (crises are inevitably contagious); or a fundamentals equilibrium (crises are contagious if domestic fundamentals are weak). A calibration exercise finds that the 1995 turmoil in Argentina coexisted with a combination of risk-averse investors and weak credibility in the currency board arrangement. This turmoil could only be attributed to a Tequila effect from the Mexican crisis alone if investors were excessively risk-averse.
Keywords: Argentina, contagion, multiple equilibria, risk aversion
JEL Classification: F3, F4
Suggested Citation: Suggested Citation