| Currency crises are frequent in the 1990s with great costs, which provoke extensive research to study the mechanism. Reviewing the currency crises literature, mostly they don't refer to the key role played by small-media investors. They regard the investors to be identical and make simple hypothesis about the expectation. But judging from the experiences, larger players can't gender currency crises without small-media investors.Facing negative shocks, small-media investors operate through the security markets and foreign exchange markets, whose behavior are examined respectively.In the security markets, I use information-friction models to show when small-media investors are going to herd. With the development of financial liberalization, large players with higher capability in information processing can benefit from that winning a better position in the market. Because of the restriction of small capital and short position, small-media players have not diversified internationally as much as they can. As a result they invest at home more than any portfolio theory can predict. That's why they are the stabilizing forces in the markets unless there are extremely bad news. The other side of story is that small-media players will have noise trade without capabilities of information processing.Thus, there are 3 suggestions in the security markets. First, the more large players diversified, the more strongly they response to negative news leading to volatility. If the supervision structure do not adapt simultaneously, we should slow down the speed of financial liberalization. Second, the position of large players should be known by small-media players. After that, it's impossible for large players to make a profit by spreading false news and taking a corresponding position. Everyone can see through his trick. As a result, markets are stabilized. Third, disclosure of fundamentals will benefit the market. On the one hand, false news of this kind will not spread to cause a panic. On the other hand, small-media investors will invest more rationally. In other words, they will be confident about home market.Following game-theory version of bank run, I figure out the behavior of small-media investors in foreign exchange market. Starting from the two investor's case, I picture when the investors will herd and count the probability of currency crises. The model shows that central bank can enhance the currency either by giving additional bonus or taxing. The bonus approach should be designed carefully. Only when all the bonus goes to the stable investor where the other one flee, and divided where both flee, can it decrease the probability of currency crises. The tax approach which includes unit tax taxes and advalorem tax will definitely increase the probability of currency stability.Both approaches have disadvantages or problems to be solved. We check the bonus approach first. Before adopting the approach, we need to figure out the timing of currency crisis. Then, whether small-media investors convert or not is private information. They may change mind when the bonus approach are initialized. Thus, the cost of the central bank will be larger in this case. Third, after extending to the pessimistic expectation case, the central bank should have more additional foreign exchange to achieve assumed target which leads to the source problem of extra foreign exchange. (1)We need to know the timing of adopting, (2)the level of tax and(3) paying attention to capital fly for the tax approach.Chinese small-media investors are less mature than the counterparts in developed countries. They herd more often. After the liberalization, we expose to new speculative attack pressure:(1) Large players in China will diversified more, so they are more sensitive to unverified news.(2) Large players from other countries may turn to noise trade to make a profit for the cost of information processing is large for them. (3) China will expose to more shocks directly after the liberalization. All the speculative attack pressure may work o...
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