Discussion Paper Series 2004-E-22

Contagion of Currency Crises across Unrelated Countries

Kenshi Taketa

This paper shows that a currency crisis can spread from one country to another even when these countries are unrelated in terms of economic fundamentals. The propagation mechanism lies in each speculator's private information about hisher own type and learning behavior about other speculators' types. Since the payoff of each speculator depends on the behavior of other speculators as determined bytheir types, each speculator's behavior depends on hisher belief about other speculators' types. If a crisis in one country reveals the speculator types, it leads to a revision of each speculator's beliefs about other speculators' types and therefore a change in hisher optimal behavior, which in turn can cause a crisis even in another unrelated country. This paper also shows that the better the economic fundamentals in the country where the crisis originates, the more contagious the original crisis can be.

Keywords: Contagion; Currency Crises; Global Game.

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2004 Bank of Japan All Rights Reserved.

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