INTRODUCTION

It is not surprising that the increasing turmoil in global financial markets has stimulated interest in models with multiple equilibria, where the jumps between equilibria are triggered by extraneous events. What has seemed most striking about the crises in the mid– to late 1990s is that their timing and virulence seem quite unrelated to the fundamental problems facing the countries and markets concerned. For instance, though the crisis in Mexico in 1994–1995 seems to have among its causes an overvalued exchange rate and a large current account deficit, the devaluation of December 1994, which should have served to help solve these problems, instead led to a loss of confidence, a free‐fall of the exchange rate, and the prospect of a massive default on exchange–rate– linked foreign debt, the tesobonos.

In addition, crises have triggered severe attacks on other currencies, where the trade and capital flow linkages between countries have been weak. This includes the contagion from Mexico to Argentina and Brazil, the contemporaneous crises in many East Asian countries in 1997, and the rippling effects of the Russian default in August 1998 on many emerging markets and even on U.S. corporate debt and mortgage backed securities spreads, resulting in a severe liquidity crisis that nearly brought down the hedge fund Long–Term Capital Management (LTCM).