When the penny doesn’t drop – Macroeconomic tail risk and currency crises

Publication date: 18 Nov 2020 | Publication type: NIESR Discussion Paper | External Author(s): Duley, C; Gai, P | JEL Classification: F31, G01, E44, N24 | NIESR Discussion Paper Number: 520


We extend the canonical global game model of currency crises to allow for macroeconomic tail risk. The exchange rate peg is attacked if fundamentals reach a critical threshold, or if there is a sufficiently large public shock. Large shocks generate doubt amongst investors about both the state of the world and about what others know, giving rise to multiple equilibria. We find a non-monotonic relationship between tail risk and the probability of (a fundamentals-based) crisis and show how this effect depends on the magnitude and direction of public shocks. Our analysis sheds new light on the way in which international financial contagion played a part in the sterling crisis of 1931.


Keyword tags: 
Global games
currency crises
rank beliefs
inter-war gold standard
sterling crisis of 1931