The Role of Portfolio Constraints in the International Propagation of Shocks

54 Pages Posted: 24 Feb 2005

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: September 2007

Abstract

We study the comovement among stock prices and among exchange rates in a three-good three-country Center-Periphery dynamic equilibrium model in which the Center'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 Center, 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: International finance, asset pricing, terms of trade, portfolio constraints, contagion

JEL Classification: G12, G15, F31, F36

Suggested Citation

Pavlova, Anna and Rigobon, Roberto, The Role of Portfolio Constraints in the International Propagation of Shocks (September 2007). EFA 2006 Zurich Meetings Paper; MIT Sloan Working Paper; AFA 2008 New Orleans Meetings Paper. Available at SSRN: https://ssrn.com/abstract=671787 or http://dx.doi.org/10.2139/ssrn.671787

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 )

E52-447
Cambridge, MA 02142
United States
617-258-8374 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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