Self-Fulfilling Risk Predictions: An Application to Speculative Attacks

34 Pages Posted: 15 Feb 2006

See all articles by Robert P. Flood

Robert P. Flood

International Monetary Fund (IMF) - Research Department; CENTRUM Business School; National Bureau of Economic Research (NBER)

Nancy Peregrim Marion

Dartmouth College - Department of Economics

Date Written: August 1998

Abstract

The paper shows that changing market beliefs about currency risk can generate a self-fulfilling speculative attack on a fixed exchange rate. The attack does not require a later change in policies to make it profitable. This is illustrated by introducing an endogenous risk premium into a "first-generation model" of a speculative attack. The model is further modified to take account of sterilization, debt-financed fiscal deficits, and anticipatory price-setting behavior. The model is used to interpret the 1994 Mexican peso crisis.

Keywords: Currency crisis, devaluation, risk premium, Mexico

JEL Classification: F3, F4

Suggested Citation

Flood, Robert P. and Marion, Nancy P., Self-Fulfilling Risk Predictions: An Application to Speculative Attacks (August 1998). IMF Working Paper No. 98/124, Available at SSRN: https://ssrn.com/abstract=882672

Robert P. Flood (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

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Washington, DC 20431
United States
202-623-7667 (Phone)
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CENTRUM Business School

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Los Alamos de Monterrico
Surco, Lima, Lima 00001
Peru

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Nancy P. Marion

Dartmouth College - Department of Economics ( email )

Hanover, NH 03755
United States
(603) 646-2511 (Phone)

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