Does One Soros Make a Difference? A Theory of Currency Crises with Large and Small Traders
Abstract (via Hyunsongshin)
Do large investors increase the vulnerability of a country to speculative attacks in the foreign exchange markets? To address this issue, we build a model of currency crises where a single large investor and a continuum of small investors independently decide whether to attack a currency based on their private information about fundamentals. Even abstracting from signaling, the presence of the large investor does make all other traders more aggressive in their selling. Relative to the case in which there is no large investor, small investors attack the currency when fundamentals are stronger. Yet, the difference can be small, or non-existent, depending on the relative precision of private information of the small and large investors. Adding signalling makes the inÀuence of the large trader on small traders’ behaviour much stronger.
Excerpt (Via Hyunsongshin)
A commonly encountered view among both seasoned market commentators and less experienced observers of the financial markets is that large traders can exercise a disproportionate in infuence on the likelihood and severity of a financial crisis by fermenting and orchestrating attacks against weakened currency pegs. The famously acrimonious exchange between the financier George Soros and Dr. Mahathir, the prime minister of Malaysia at the height of the Asian crisis is a prominent example in which such views have been aired and debated. The issues raised by this debate are complex, but they deserve systematic investigation