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Wealth Transfers, Contagion and Portfolio Constraints

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Author Info
Pavlova, Anna
Rigobon, Roberto

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Abstract

This paper examines the co-movement among stock market prices and exchange rates within a three-country Centre-Periphery dynamic equilibrium model in which agents in the Centre country face portfolio constraints. In our model, international transmission occurs through the terms of trade, through the common discount factor for cash flows, and, finally, through an additional channel reflecting the tightness of the portfolio constraints. Portfolio constraints are shown to generate endogenous wealth transfers to or from the Periphery countries. These implicit transfers are responsible for creating contagion among the terms of trade of the Periphery countries, as well as their stock market prices. Under a portfolio constraint limiting investment of the Centre country in the stock markets of the Periphery, stock prices also exhibit a flight to quality: a negative shock to one of the Periphery countries depresses stock prices throughout the Periphery, while boosting the stock market in the Centre.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5117.

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Date of creation: Jul 2005
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Handle: RePEc:cpr:ceprdp:5117

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Related research
Keywords: asset pricing; contagion; international finance; portfolio constraints; terms of trade;

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Find related papers by JEL classification:
F31 - International Economics - - International Finance - - - Foreign Exchange
F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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References listed on IDEAS
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Broner, Fernando A & Lorenzoni, Guido & Schmukler, Sergio, 2007. "Why Do Emerging Economies Borrow Short Term?," CEPR Discussion Papers 6249, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Stavros Panageas, 2009. "Bailouts, the Incentive to Manage Risk, and Financial Crises," NBER Working Papers 15058, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Suleyman Basak & David Cass & Juan Manuel Licari & Anna Pavlova, 2006. "Multiplicity in General Financial Equilibrium with Portfolio Constraints, Second Version," PIER Working Paper Archive 06-020, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 17 Jul 2006. [Downloadable!]
  4. Basak, Suleyman & Cass, David & Licari, Juan Manuel & Pavlova, Anna, 2006. "Multiplicity in General Financial Equilibrium with Portfolio Constraints," CEPR Discussion Papers 5804, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  5. Suleyman Basak & David Cass & Juan Manuel Licari & Anna Pavlova, 2006. "Multiplicity and Sunspots in General Financial Equilibrium with Portfolio Constraints," PIER Working Paper Archive 06-012, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
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