Speculative attack

In economics, a speculative attack is a precipitous selling of untrustworthy assets by previously inactive speculators and the corresponding acquisition of some valuable assets (currencies, gold). 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 adapted their mechanism to explain speculative attacks in the foreign exchange market. 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. A speculative attack in the foreign exchange market is the massive and sudden selling of a nation's currency, and can be carried out by both domestic and foreign investors. A speculative attack primarily targets currencies of nations that use a fixed exchange rate and have pegged their currency to a foreign currency, such as Hong Kong pegging the Hong Kong Dollar (HK$) to the United States Dollar (US$) at an exchange rate of HK$7.8 to US$1; generally the target currency is one whose fixed exchange rate may be at an unrealistic level that may not be sustainable for very much longer even in the absence of a speculative attack. In order to maintain a fixed exchange rate, the nation's central bank stands ready to buy back its own currency at the fixed exchange rate, paying with its holdings of foreign exchange reserves. If foreign or domestic investors believe that the central bank does not hold enough foreign reserves to defend the fixed exchange rate, they will target this nation's currency for a speculative attack. The investors do this by selling that country's currency to the central bank at the fixed price in exchange for the central bank's reserve currency, in an attempt to deplete the central bank's foreign reserves.