Predicting Currency Crises with a Nested Logit Model

This paper is the first to apply a nested logit model to measure the probabilities of speculative attacks and the probabilities of successful defenses by the central banks. This model allows us to predict not only the probability of speculative attacks but also the probability of successful defenses given attacks. Also, it provides a framework to analyze the degree to which different factors affect the likelihood of attacks and defenses. This paper finds strong evidence that external illiquidity and financial fragility are reliable predictors of currency crises. The results shed lights on the validity of the three generations of currency crisis models. (JEL: F31 and F32) ∗Address for correspondence: Department of Economics and Finance, City University of Hong Kong, Tat Chee Avenue, Kowloon, Hong Kong. Email: [email protected]. Tel: +852-2788-7315; Fax: +852-2788-8806. We would like to thank the participants of the International Economics Seminar at the Stanford University and the City University of Hong Kong for helpful comments. This work is supported by the Research Center for International Economics (RCIE) at the City University of Hong Kong. †Shortened Title: Currency Crises Prediction