BALANCE OF PAYMENTS CRISES IN AN OPTIMAL PORTFOLIO MODEL

Balance of payments crises are often associated with large current account movements preceding and following the crises. In this paper we treat the issue of balance of payments crises in a general equilibrium model to allow for such current account movements. At the same time, we model the portfolio decisions of the individuals in an explicit risk and return framework. The resulting behavior for money demand, foreign exchange reserves and current account is derived. Most importantly, the risk and return framework allows for a discussion of the influence of uncertain government domestic credit policies on the current account behavior preceding the attack and on the probability of an attack. © 1991.