A Model of Contagious Currency Crises with Application to Argentina

Author: Ms. Nada Choueiri

Volume/Issue: Volume 1999 Issue 029

Publication date: March 1999

ISBN: 9781451844788

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Topics covered in this book

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Investments and Securities-General , WP , exchange rate , Argentina , contagion , multiple equilibria , risk aversion , fixed exchange rate system , degree of risk aversion , Argentina's economy , exchange rate crisis , contagion effect , crisis in Mexico , exchange rate peg , investors' degree , Exchange rates , Return on investment , Conventional peg , Exchange rate arrangements , Floating exchange rates , Asia and Pacific

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Summary

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.