Devaluation without common knowledge

Working paper

In an economy with a fixed exchange rate regime that suffers a random adverse shock, we study the strategies of imperfectly and sequentially informed speculators that may trigger an endogenous devaluation before it occurs exogenously. The game played by the speculators has a unique symmetric Nash equilibrium which is a strongly rational expectation equilibrium in the set of all strategies with delay. Uncertainty about the extent to which the Central Bank is ready to defend the peg extends the ex ante mean delay between the exogenous shock and the devaluation. We determine endogenously the rate of devaluation.

Authors: Rochon, C

• Publication status: Published
• Publisher: University of Oxford
• Series: Department of Economics Discussion Paper Series
• Publication date: 2006-02-01
• Paper number: 2006-FE-03
• Keywords: fixed exchange rate regime; speculation; endogenous devaluation; imperfect information; currency crises