DP1990 Currency Crises, Sunspots and Markov-Switching Regimes

Author(s): Olivier Jeanne, Paul R Masson
Publication Date: October 1998
Keyword(s): Currency Crises, European Monetary System, French franc, Markov-switching regimes, Self-Fulfilling Speculation, Sunspots
JEL(s): F3, F4
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1990

This paper investigates the theoretical properties of a class of 'second generation' models of currency crises as well as their applicability to empirical work. We show that under some conditions these models give rise to an arbitrarily large number of equilibria, as well as cyclic or chaotic dynamics for the devaluation expectations. We then propose an econometric technique, based on the Markov-switching regimes framework, by which these models can be brought to the data. We illustrate this empirical approach by studying the experience of the French franc between 1987 and 1993, and find that the model performs significantly better when it allows the devaluation expectations to be influenced by sunspots.