Fluctuating Attention and Financial Contagion

55 Pages Posted: 18 Jan 2015 Last revised: 30 Jul 2018

See all articles by Michael Hasler

Michael Hasler

University of Neuchatel

Chayawat Ornthanalai

University of Toronto - Rotman School of Management

Date Written: June 10, 2018

Abstract

Financial contagion occurs when return and volatility transmit between fundamentally unrelated sectors. Our equilibrium model shows that contagion arises because investors pay fluctuating attention to news. As a negative shock hits one sector, investors pay more attention to it. This raises the volatility of equilibrium discount rates resulting in simultaneous spikes in cross-sector correlations and volatilities. We test the economic mechanism of the model on fundamentally unrelated U.S. industries, which are identified using their customer-supplier relationships. Consistent with the model's predictions, empirical evidence shows that fluctuating attention generates return and volatility spillovers between fundamentally unrelated industries.

Keywords: Asset Pricing; General Equilibrium; Learning; Attention; Contagion

JEL Classification: G12; G13; G14

Suggested Citation

Hasler, Michael and Ornthanalai, Chayawat, Fluctuating Attention and Financial Contagion (June 10, 2018). Journal of Monetary Economics, Forthcoming, Rotman School of Management Working Paper No. 2551085, Available at SSRN: https://ssrn.com/abstract=2551085 or http://dx.doi.org/10.2139/ssrn.2551085

Michael Hasler (Contact Author)

University of Neuchatel

2, A.-L. Breguet
Neuchatel, CH-2000
Switzerland

Chayawat Ornthanalai

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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