Vulnerability of currency pegs: evidence from Brazil

This paper analyses predictions of a simple model of currency crises in which the peg will beabandoned when the currency overvaluation hits a certain threshold, unknown to the agents. Due tolearning about the threshold, some features usually observed in the data and identified with modelswith multiple equilibria arise in the model. But the model yields distinctive predictions about thebehaviour of the probability and the expected magnitude of a currency devaluation. The paperidentifies the probability and expected magnitude of a devaluation of Brazilian Real in the periodleading up to the end of the Brazilian pegged exchange rate regime, using data on exchange rateoptions. The empirical results are consistent with model predictions.[...]