When in Peril, Retrench: Testing the Portfolio Channel of Contagion

36 Pages Posted: 19 Dec 2004

See all articles by Fernando Broner

Fernando Broner

CREI; Barcelona GSE; Universitat Pompeu Fabra; CEPR

Gaston Gelos

International Monetary Fund

Carmen M. Reinhart

Peter G. Peterson Institute for International Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: December 2004

Abstract

One plausible mechanism through which financial market shocks may propagate across countries is through the effect of past gains and losses on investors' risk aversion. The paper first presents a simple model examining how heterogeneous changes in investors' risk aversion affects portfolio decisions and stock prices. Second, the paper shows empirically that, when funds' returns are below average, they adjust their holdings toward the average (or benchmark) portfolio. In other words, they tend to sell the assets of countries in which they were "overweight", increasing their exposure to countries in which they were "underweight." Based on this insight, the paper discusses a matrix of financial interdependence reflecting the extent to which countries share overexposed funds. Comparing this measure to indices of trade or bank linkages indicates that our index can improve predictions about which countries are likely to be affected by contagion from crisis centers.

Suggested Citation

Broner, Fernando and Gelos, R. Gaston and Reinhart, Carmen M., When in Peril, Retrench: Testing the Portfolio Channel of Contagion (December 2004). NBER Working Paper No. w10941. Available at SSRN: https://ssrn.com/abstract=629583

Fernando Broner

CREI ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

HOME PAGE: http://www.crei.cat/people/broner

Barcelona GSE

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2601 (Phone)

HOME PAGE: http://www.crei.cat/people/broner

CEPR ( email )

London
United Kingdom
+34 93 542 2601 (Phone)

R. Gaston Gelos

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Carmen M. Reinhart (Contact Author)

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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