Speculative Attacks : Panic or Arbitrage?

This paper formulates a second generation currency crises model, which is consistent with many facts regarding the structural economies in Southeast asia. Emphasis is laid on the propagation mechanism from a financial crisis to a currency crisis. Micro-foundation, endogenous labour supply, and nominal wage rigidity are key features of our model. It has the same closed form solution as previous second generation models. We then formulate a statistical test, which tests the null-hypothesis of an "arbitrage" crisis against a "panic" crisis alternative, without needing any measure of fundamentals. The test amounts to a test for whether there are discrete jumps in a measure of a devaluation probability. Thus, the test requires as input only a time series of devaluation probabilities, and these are estimated for five Asian countries using a probit-Markov model. The results show big inter-country diffencies in the characterization of the recent crisis in terms of credibility and the role of fundamentals