Cabinet Collapses and Currency Crashes

Abstract

Asset market performance conditions the strategic context of cabinet terminations. In turn, information about cabinet terminations shapes how market actors evaluate the government's commitment to specific policies, affecting overall economic performance. To understand how the economy affects cabinet terminations, therefore, we must account for the endogeneity between cabinet outcomes and market performance. In this article, we model both cabinet terminations and speculative currency attacks. We argue that changes in the probability of different types of cabinet ends condition the probability that currency traders will sharply shift their assets out of a country. In turn, the probability of a speculative attack influences the probabilities of different types of cabinet ends—for instance, the higher the likelihood of speculative attack, the lower the chance of an early strategic election. We connect separate models of cabinet termination and speculative attacks using an instrumental-variables framework.

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