Currency crisis: Evolution of beliefs and policy experiments

We study a model of currency crisis where agents’ beliefs are the only source of volatility containing the potential for currency devaluation. Using the basic framework of Arifovic and Masson (2003), we simulate the model for a large number of parameter specifications. The learning dynamics of our agent-based computational model, based on imitation of successful expectational rules and occasional experimentation, result in recurrent currency crises. Recurrent crises are a robust feature of the dynamics regardless of the model's parameter specifications. We discuss both the impact of imitation and experimentation on the model's dynamics, as well as the impact of the parameter values on the duration of episodes of devaluation and periods of no-devaluation. In addition, we compare the first difference in interest rate spread statistics of the data generated in our simulations and real world data. Finally, we conduct policy experiments in our agent-based type environment designed to examine the power of the interest rate policy changes in decreasing the number as well as the duration of the episodes of currency crisis. Our results indicate that the policy of decreasing, rather than increasing, the emerging market interest rate proves more effective at reducing the likelihood of devaluation.