The Asian Financial Crisis
Causes, Contagion and Consequences
Edited by Pierre-Richard Agénor
Edited by Marcus Miller
Edited by David Vines
Edited by Axel Weber
Global Economic Institutions (No. 2)
Publisher: Cambridge University Press
Print Publication Year: 1999
Online Publication Date:February 2010
Chapter DOI: http://dx.doi.org/10.1017/CBO9780511559587.016
Chapter 7 takes further the ideas of Morris and Shin (1998) in that it allows for more natural Brownian-motion representation of fundamentals. In addition the chapter assumes that the information of market participants about the true value of the fundamental is distributed according to a normal distribution about the true value, as opposed to a uniform distribution in the earlier paper. This allows the authors to tell a dynamic story about when a currency attack might occur, and also to examine what happens when the nature of the differential private information is varied. The results remain startling: a tiny departure from common knowledge entirely eliminates the multiplicity of equilibria. This work represents a major challenge to the traditional multiple-equilibrium models of currency attacks, most notably associated with Obstfeld (1986, for example). Of course the insights here are also applicable to other market situations with similar multiple-equilibrium properties, such as bank-run models.
The arguments of the chapter, however, are technical and it is difficult to get a clear idea of why a small departure from common knowledge about the fundamental can lead to such a radical change in the set of equilibria. So I will start by attempting an overview of the argument, before discussing the extent to which I think these insights are important.