Speculative attacks on currencies

Abstract

This Thesis is about currency crises. A Currency Crisis, sometimes referred to as Balance of Payment crisis, is the devaluation of the currency i.e. when a currency loses its value after a successful speculative attack leading to the exhaustion of foreign reserves, and thus, the abandonment of the parity. The thesis consists of three chapters. The first chapter includes an overview of the economic theory behind fixed exchange rates in order to gain an understanding of the mechanism of how central banks defend their currencies under a fixed exchange rate regime, and the motivation for adopting such a regime. The second chapter includes a literature review of the competing theories, where each theory tries to explain the root causes of currency crises. The Third Chapter runs a probit model analysis on data collected on 100 countries that underwent currency crises since 1971. The methodology in the econometric analysis is to use explanatory variables suggested by the competing theories. The model is used to vet the competing theories based on the significance of the variables. Both first and second generation models type of attack found to be significant in explaining currency crashes.