Speculative attack

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A speculative attack is a term used by economists to denote a precipitous acquisition of some assets (currencies, gold, emission permits, remaining quotas) by previously inactive speculators. The first model of a speculative attack was contained in a 1975 discussion paper on the gold market by Stephen Salant and Dale Henderson at the Federal Reserve Board. Paul Krugman, who visited the Board as a graduate student intern, soon [1] adapted their mechanism[2] to explain speculative attacks in the foreign exchange market.[3]

There are now many hundreds of journal articles on financial speculative attacks, which are typically grouped into three categories: first, second, and third generation models. Salant has continued to explore real speculative attacks in a series of six articles.

Dynamics

Speculative attack in the foreign exchange market is the massive selling of a country's currency assets by both domestic and foreign investors. Countries that utilize a fixed exchange rate are more susceptible to a speculative attack than countries utilizing a floating exchange rate. This is because of the large amount of reserves necessary to hold the fixed exchange rate in place at that fixed level. Nevertheless, if a government chooses to maintain a fixed exchange rate during a speculative attack, they risk the chance of severe economic depression or financial collapse, as illustrated by the Argentine and East Asian financial crises.

A speculative attack has much in common with cornering the market, as it involves building up a large directional position in the hope of exiting at a better price. As such, it runs the same risk: a speculative attack relies entirely on the market reacting to the attack by continuing the move that has been engineered, in order for profits to be made by the attackers. In a market that is not susceptible, the reaction of the market may, instead, be to take advantage of the change in price by taking opposing positions and reversing the engineered move.

This may be assisted by aggressive intervention by a central bank, either directly through very large currency transactions or through raising interest rates, or by activity by another central bank with an interest in preserving the current exchange rate. As in cornering the market, this leaves the attackers vulnerable.

See also

References

  1. ↑ Krugman
  2. ↑ Stephen Salant and Dale Henderson (1978), "Market anticipations of government policies and the price of gold." Journal of Political Economy 86, pp.627-48
  3. ↑ Paul Krugman (1979), 'A model of balance-of-payments crises'. Journal of Money, Credit, and Banking 11, pp. 311-25.
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