Speculative attacks to currency target zones: A market microstructure approach

This paper develops a simple optimization model to characterize the behaviour of market participants during currency attacks and tests it empirically. Specifically, we test for the determinants of the timing, magnitude and chance of success of an attack. The empirical part is carried out using Mexican data, as this market provides us with an appropriate target zone framework and with a very rich dataset. We find empirical support for a set of microeconomic determinants which include: daily order flow, inventory management, intra-day price volatility, and the forward intervention-price differential. Finally, we test for the role of central bank reserves in speculative attack dynamics.