The Role of Portfolio Constraints in the International Propagation of Shocks

57 Pages Posted: 5 Jun 2008

See all articles by Anna Pavlova

Anna Pavlova

London Business School; Centre for Economic Policy Research (CEPR)

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: January 2008

Abstract

We study the comovement among stock prices and among exchange rates in a three-good three-country Centre-Periphery dynamic equilibrium model in which the Centre's agents face portfolio constraints. We characterize equilibrium in closed form for a broad class of portfolio constraints, solving for stock prices, terms of trade, and portfolio holdings. We show that portfolio constraints generate wealth transfers between the Periphery countries and the Centre, which increase the comovement of the stock prices across the Periphery. We associate this excess comovement caused by portfolio constraints with the phenomenon known as contagion. The model generates predictions consistent with other important empirical results such as amplification and flight-to-quality effects.

Keywords: Asset pricing, contagion, International finance, portfolio constraints, terms of trade, wealth transfer

JEL Classification: F31, F36, G12, G15

Suggested Citation

Pavlova, Anna and Rigobon, Roberto, The Role of Portfolio Constraints in the International Propagation of Shocks (January 2008). , Vol. , pp. -, 2008. Available at SSRN: https://ssrn.com/abstract=1140576

Anna Pavlova (Contact Author)

London Business School ( email )

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HOME PAGE: http://faculty.london.edu/apavlova

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Cambridge, MA 02142
United States
617-258-8374 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

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