When the penny doesn't drop - Macroeconomic tail risk and currency crises

Chanelle Duley () and Prasanna Gai ()

No 520, National Institute of Economic and Social Research (NIESR) Discussion Papers from National Institute of Economic and Social Research

Abstract: We extend the canonical global game model of currency crises to allow for macroeconomic tail risk. The exchange rate peg is attacked if fundamentals reach a critical threshold, or if there is a sufficiently large public shock. Large shocks generate doubt amongst investors about both the state of the world and about what others know, giving rise to multiple equilibria. We find a non-monotonic relationship between tail risk and the probability of (a fundamentals-based) crisis and show how this effect depends on the magnitude and direction of public shocks. Our analysis sheds new light on the way in which international financial contagion played a part in the sterling crisis of 1931.

Keywords: Global games; currency crises; rank beliefs; inter-war gold standard; sterling crisis of 1931 (search for similar items in EconPapers)
JEL-codes: E44 F31 G01 N24 (search for similar items in EconPapers)
Date: 2020-11
New Economics Papers: this item is included in nep-his, nep-mac, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:nsr:niesrd:520

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