Foreign devaluation as a coordinating device of heterogeneous investors: A game‐theoretic analysis of financial contagion

This paper investigates financial contagion by extending the Morris–Shin (1998) model of financial crises. It is assumed that before a devaluation in a foreign country, home investors have only private information on the state of the home country. It is demonstrated that the occurrence of a currency crisis in the foreign country may trigger a similar crisis in the home country by coordinating heterogeneous beliefs of home investors. The model is designed to describe the Asian currency crisis of 1997.