A Theory of the Onset of Currency Attacks

The swiftness and devastating impact of recent financial crises have taken many market participants by surprise and pose challenges for economists seeking a theory of the onset of a crisis. We propose such a theory based on two features. The actions of diverse economic actors which undermine the currency are mutually reinforcing, while the fragmented nature of the media create small disparities in their information. In such circumstances, the beliefs of market participants can be tracked in the same way as the economic fundamentals and an attack is triggered when the economic fundamentals deteriorate sufficiently to fall below the minimum level of market confidence necessary to support the currency. We give a characterization of such a minimum level of confidence.