Financial Contagion and the Wealth Effect: An Experimental Study
32 Pages Posted: 2 Mar 2020 Last revised: 3 Aug 2020
Date Written: January 1, 2020
We design a laboratory experiment to test the importance of wealth as a channel for financial contagion across markets with unrelated fundamentals. In a sequential global game,
we analyze the decisions of a group of investors that hold assets in two markets. We consider
two treatments that vary the level of diversification of these assets across markets. In both
treatments, we nd evidence of financial contagion. When investors have completely diver-
sied portfolios, we provide evidence of contagion due to a wealth effect: for certain ranges
of fundamentals, we show that a decrease in wealth from the investment in the first mar-
ket makes withdrawals more likely in the second, thereby increasing the probability of a crisis.
When portfolio diversification is small, then social imitation is relevant in explaining contagion.
Keywords: Financial contagion, financial crises, wealth, coordination games, global games
JEL Classification: C72; C92; D8; G01; G11
Suggested Citation: Suggested Citation