Investigating the feasibility of the double-play strategy: evidence from Hong Kong’s speculative attacks

ABSTRACT

This paper examines the ‘double-play’ strategy adopted by speculators during currency attacks in Hong Kong. We modify the speculators’ objective function to interpret how they earned potential returns from the automatic mechanism of the linked exchange rate system. Furthermore, we investigate the dynamic conditional correlations among currency, stock and derivatives markets, and identify the key determinants for these relationships during speculative attacks. Our findings offer a comprehensive insight into the behaviour of speculators during currency attacks, and provide compelling empirical support for the impact of central bank interventions on market dynamics.

KEYWORDS:

• Currency crisis
• speculative attacks
• government intervention
• Hong Kong

JEL CLASSIFICATION:

• F31
• G15
• G18

Acknowledgments

We would like to thank Robert Webb for many helpful comments and suggestions. We are also very grateful to Mark BLISS and Agatha Wong-Fraser for their sincere and significant supports in the paper amendment.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Supplementary material

Supplemental data for this article can be accessed online at https://doi.org/10.1080/13504851.2024.2349131

Notes

¹ In 1997, the HK official foreign exchange reserves were US$88 billion, the third largest reserves in the world. Extensive papers (Norman 2019) document that the HK government used approximately HK$120 (US$15) billion from its own Foreign Exchange Funds to defend the LER. The collapse of LTCM and the Russian financial crisis might also be the potentially influential factors that contributed to the successful defense of the LER by the HKMA.

² The reason for this may be due to the fact that investigating the inter-relationship between currency and stock markets during speculative attacks is somewhat challenging. To empirically do this, it is suggested requires sufficient data to measure the movement of capital. Under the LER, the most direct way of measuring capital flows is to investigate the monetary base. However, the monetary base data has been published only since November 1998.

³ These financial instruments played a crucial role in the second speculative attack as they provided speculators with various advantages, such as leverage and hedging. For example, speculators could effectively manage a substantial HSIF contract value with a relatively modest capital. Without loss of generality, we assume that there is no dividend, and the short-seller (speculator) fulfils the initial margin requirement.

⁴ Auten (1963) indicates that a large-scale speculative attack should cause the forward rate to depart widely from its interest rate parity values thus leading to an arbitraging capital outflow. The fsd might be a good alternative to measure capital movement when the monetary base data is not available. An increase in fsd is considered as capital outflow during speculative attacks.

⁵ The descriptive statistic and preliminary tests are reported in appendix 1.

⁶ In this analysis, the EGARCH model outperforms the other specifications. Notably, persistence is determined by ${\beta }_1$ in the EGARCH model. Due to space constraints, the robustness check for DCC model is reported in appendix 2.

⁷ The settlement day of HSI futures and options.

⁸ The multiple breakpoint test is used on the fsd to determine the break date of the two speculative attack timeframes. (Appendix 1):

⁹ As mentioned, data availability was the main limitation of this study. For the countries adopting fixed or linked exchange rate regime, monetary base data would provide more accurate measure for international capital movement.

¹⁰ For example, implementing measures such as increasing the initial margin requirement and imposing short sale restrictions. Vigilantly monitoring unusual activities in the derivatives market would undoubtedly prove to be fruitful in preventing speculative attacks.