The role of a large trader in a dynamic currency attack model |
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| Institution: | 1. Department of Economics and Finance, University of Guelph, 50 Stone Road East, Guelph, Ontario N1G 2W1, Canada;2. Department of Economics, Queen’s University, 94 University Avenue, Kingston, Ontario K7L 3N6, Canada;1. Research Department, Financial Stability Wing, Norges Bank (Central Bank of Norway), Bankplassen 2, P.O. Box 1179 Sentrum, 0107 Oslo, Norway;2. Market Infrastructure Division, Financial Stability, Bank of England, Threadneedle Street, London EC2R 8AH, United Kingdom;1. Department of Economics, Carleton University, Canada;2. School of Accounting and Finance, University of Waterloo, Canada;1. London School of Economics, United Kingdom;2. Tel Aviv University, Israel;3. University College London, United Kingdom;4. CFM, United Kingdom;1. PUC-Rio, Department of Economics, Brazil;2. PUC-Rio, Department of Economics, Itaú BBA, Brazil;1. The Blavatnik School of Computer Science, Tel-Aviv University, Tel-Aviv, 69978, Israel;2. Grupo de Medicina Xenómica, Universidad de Santiago de Compostela, Centro Nacional de Genotipado - Instituto Carlos III, Centro de Investigación Biomédica en Red de Enfermedades Raras, Santiago de Compostela 15782, Spain;3. Fundación Pública Galega de Medicina Xenómica, Servicio Galego de Saúde, Instituto de Investigación Sanitaria de Santiago de Compostela, Hospital Clínico Universitario, Santiago de Compostela 15782, Spain;4. Department of Pathology and Laboratory Medicine, David Geffen School of Medicine, University of California, Los Angeles, Los Angeles, CA 90024, USA;5. Jonsson Comprehensive Cancer Center, University of California, Los Angeles, Los Angeles, CA 90024, USA;6. Department of Molecular Microbiology and Biotechnology, Tel-Aviv University, Tel-Aviv, 69978, Israel;7. International Computer Science Institute, 1947 Center Street, Berkeley, CA 94704, USA |
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| Abstract: | This paper studies the role of a large trader in a dynamic currency attack model based on Abreu and Brunnermeier (2003), who study stock market bubbles and crashes in a dynamic model with a continuum of rational small traders. We introduce a large trader into their model and apply it to currency attacks. In an attack against a fixed exchange rate regime with a gradually overvalued currency, traders lack common knowledge about the time when the overvaluation starts and need to coordinate to break a peg. Both the inability of traders to synchronize their attack and their incentive to time the collapse of the regime lead to the persistent overvaluation of the currency. We find that the presence of a large trader with perfect information induces small traders to attack sooner and leads to an accelerated collapse of the regime. But the presence of a large trader with noisy information may delay the collapse of the regime ex post. Moreover, a large trader with precise information tends to be at the rear of an attack. With noisy information, he could attack earlier or later than small traders. In both cases, the large trader affects market dynamics of the attack substantially. |
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| Keywords: | Large traders Currency attacks Hedge funds |
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