2 Currency Crisis Model Consider the model we had in lecture. Each investor has one million pounds and is choosing to invest in pounds or in marks. The government has B pounds worth of marks in its foreign reserves that it is willing to use to defend a xed exchange rate. There are a total of 299-9 investors. 1. Imagine you were an individual investor, and could observe the government's stockpile B and every other investor's actions. Suppose B is one billion pounds [for only this question}. Call D the number of other investors that invest in marks. Describe your best reponse as a function of D. What are the possible Nash equilibria? 1 2. Suppose that you couldn't observe the other investor's actions, but you did know their strategies. 59E} of the other investors invest in marks if B is less than a billion. The other 1591'} invest in marks if B is less than 59-9 million. What is your best response to these strategies, as a function of B? 3. In the last question, was every investor playing a best response? 1rWho was not? 4. Now suppose no one sees the true B. Instead everyone sees 3;, which is distributed uniformly between B 1 and B + 1. Assume everyone else adopts the cutoff strategy that if the B, they see is less than 599 million pounds, they will invest in marks, and if their B,- is above 509 million pounds, they will invest in pounds. What should you do if you get a signal of B, = 699 million pounds? What if B, = 499, 999, 993 pounds? 5. If B was exactly 599 million pounds, how many investors would invest in marks? What would happen to the exchange rate? 6. What should you do if B,- = 499,999, 999.999 pounds? Hint: gure out approximately how many other investors you think are going to invest in marks. lCompare that to approximately your best guess of the reserves the government has. 1Ull'hat is going to happen to the exchange rate? What does your answer imply about the cutoff strategy that everyone else is using? Is it their best response? 7. What cutolf strategy is a Nash equilibrium