Currency substitution and speculative attacks on a currency board system

A currency board arrangement (CBA) is supposed to be robust against attacks. Currency substitution complicates life, with controversial implications for floating versus fixed exchange rate regimes. After reporting evidence of currency substitution in Hong Kong, a monetary model incorporating currency substitution is used to estimate the shadow exchange rate and the probability of speculative attack on the Hong Kong dollar. A decomposition analysis of a Markov-switching model indicates that the no-attack regime was the most durable one. This implies that Hong Kong's quasi CBA was relatively robust against both speculative attacks and currency substitution.