IDEAS home Printed from https://ideas.repec.org/p/imf/imfwpa/2004-131.html
   My bibliography  Save this paper

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

Author

Listed:
  • International Monetary Fund

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. We first present a simple model on how heterogeneous changes in investors' risk aversion affect portfolio decisions and stock prices. Second, we empirically show 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, we construct a matrix of financial interdependence reflecting the extent to which countries share overexposed funds. This index can improve predictions about which countries are likely to be affected by contagion from crisis centers.

Suggested Citation

  • International Monetary Fund, 2004. "When in Peril, Retrench: Testing the Portfolio Channel of Contagion," IMF Working Papers 2004/131, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2004/131
    as

    Download full text from publisher

    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=17488
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Andrew Berg & Catherine Pattillo, 1999. "Are Currency Crises Predictable? A Test," IMF Staff Papers, Palgrave Macmillan, vol. 46(2), pages 1-1.
    2. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
    3. Shang-Jin Wei & Mr. Gaston Gelos, 2002. "Transparency and International Investor Behavior," IMF Working Papers 2002/174, International Monetary Fund.
    4. Laura E. Kodres & Matthew Pritsker, 2002. "A Rational Expectations Model of Financial Contagion," Journal of Finance, American Finance Association, vol. 57(2), pages 769-799, April.
    5. Jennifer Lynch Koski & Jeffrey Pontiff, 1999. "How Are Derivatives Used? Evidence from the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 54(2), pages 791-816, April.
    6. Harrison Hong & Jeremy C. Stein, 2003. "Differences of Opinion, Short-Sales Constraints, and Market Crashes," The Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 487-525.
    7. Johnson, Simon & Boone, Peter & Breach, Alasdair & Friedman, Eric, 2000. "Corporate governance in the Asian financial crisis," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 141-186.
    8. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
    9. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
    10. Froot, Kenneth A. & O'Connell, Paul G. J. & Seasholes, Mark S., 2001. "The portfolio flows of international investors," Journal of Financial Economics, Elsevier, vol. 59(2), pages 151-193, February.
    11. Fernando A. Broner & Guido Lorenzoni & Sergio L. Schmukler, 2013. "Why Do Emerging Economies Borrow Short Term?," Journal of the European Economic Association, European Economic Association, vol. 11, pages 67-100, January.
    12. Garry J. Schinasi & R. Todd Smith, 2000. "Portfolio Diversification, Leverage, and Financial Contagion," IMF Staff Papers, Palgrave Macmillan, vol. 47(2), pages 1-1.
    13. Mr. Ranil M Salgado & Mr. Luca A Ricci & Mr. Francesco Caramazza, 2000. "Trade and Financial Contagion in Currency Crises," IMF Working Papers 2000/055, International Monetary Fund.
    14. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June.
    15. Eduardo Borensztein & R. Gaston Gelos, 2003. "A Panic-Prone Pack? The Behavior of Emerging Market Mutual Funds," IMF Staff Papers, Palgrave Macmillan, vol. 50(1), pages 1-3.
    16. Calvo, Guillermo A. & Mendoza, Enrique G., 2000. "Rational contagion and the globalization of securities markets," Journal of International Economics, Elsevier, vol. 51(1), pages 79-113, June.
    17. repec:bla:jfinan:v:53:y:1998:i:5:p:1589-1622 is not listed on IDEAS
    18. Hernandez, Leonardo F. & Valdes, Rodrigo O., 2001. "What drives contagion: Trade, neighborhood, or financial links?," International Review of Financial Analysis, Elsevier, vol. 10(3), pages 203-218.
    19. Busse, Jeffrey A., 2001. "Another Look at Mutual Fund Tournaments," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(1), pages 53-73, March.
    20. Brown, Keith C & Harlow, W V & Starks, Laura T, 1996. "Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 51(1), pages 85-110, March.
    21. Van Rijckeghem, Caroline & Weder, Beatrice, 2001. "Sources of contagion: is it finance or trade?," Journal of International Economics, Elsevier, vol. 54(2), pages 293-308, August.
    22. Mr. Manmohan S. Kumar & Mr. Avinash Persaud, 2001. "Pure Contagion and Investors Shifting Risk Appetite: Analytical Issues and Empirical Evidence," IMF Working Papers 2001/134, International Monetary Fund.
    23. Mr. Piti Disyatat & Mr. Gaston Gelos, 2001. "The Asset Allocation of Emerging Market Mutual Funds," IMF Working Papers 2001/111, International Monetary Fund.
    24. Albert S. Kyle & Wei Xiong, 2001. "Contagion as a Wealth Effect," Journal of Finance, American Finance Association, vol. 56(4), pages 1401-1440, August.
    25. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 92(2), pages 323-336.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Hamidreza Tabarraei, 2014. "Euro-Crisis and Spillover Effects on the Emerging Economies," PSE Working Papers halshs-00952153, HAL.
    2. repec:zbw:bofrdp:2006_015 is not listed on IDEAS
    3. Hamidreza Tabarraei, 2014. "Euro-Crisis and Spillover Effects on the Emerging Economies," Working Papers halshs-00952153, HAL.
    4. Bayoumi, Tamim & Fazio, Giorgio & Kumar, Manmohan & MacDonald, Ronald, 2007. "Fatal attraction: Using distance to measure contagion in good times as well as bad," Review of Financial Economics, Elsevier, vol. 16(3), pages 259-273.
    5. Pami Dua & Divya Tuteja, 2016. "Contagion in International Stock and Currency Markets During Recent Crisis Episodes," Working papers 258, Centre for Development Economics, Delhi School of Economics.
    6. Jokipii, Terhi & Lucey, Brian, 2007. "Contagion and interdependence: Measuring CEE banking sector co-movements," Economic Systems, Elsevier, vol. 31(1), pages 71-96, March.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Broner, Fernando A. & Gaston Gelos, R. & Reinhart, Carmen M., 2006. "When in peril, retrench: Testing the portfolio channel of contagion," Journal of International Economics, Elsevier, vol. 69(1), pages 203-230, June.
    2. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
    3. Piersanti, Giovanni, 2012. "The Macroeconomic Theory of Exchange Rate Crises," OUP Catalogue, Oxford University Press, number 9780199653126.
    4. Lizarazo, Sandra Valentina, 2013. "Default risk and risk averse international investors," Journal of International Economics, Elsevier, vol. 89(2), pages 317-330.
    5. Bekaert, Geert & Harvey, Campbell R., 2003. "Emerging markets finance," Journal of Empirical Finance, Elsevier, vol. 10(1-2), pages 3-56, February.
    6. Caramazza, Francesco & Ricci, Luca & Salgado, Ranil, 2004. "International financial contagion in currency crises," Journal of International Money and Finance, Elsevier, vol. 23(1), pages 51-70, February.
    7. Hirshleifer, David & Teoh, Siew Hong, 2008. "Thought and Behavior Contagion in Capital Markets," MPRA Paper 9164, University Library of Munich, Germany.
    8. David Hirshleifer & Siew Hong Teoh, 2003. "Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis," European Financial Management, European Financial Management Association, vol. 9(1), pages 25-66, March.
    9. Goldstein, Itay & Pauzner, Ady, 2004. "Contagion of self-fulfilling financial crises due to diversification of investment portfolios," Journal of Economic Theory, Elsevier, vol. 119(1), pages 151-183, November.
    10. Michael Chui & Simon Hall & Ashley Taylor, 2004. "Crisis spillovers in emerging market economies: interlinkages, vulnerabilities and investor behaviour," Bank of England working papers 212, Bank of England.
    11. Bank for International Settlements, 2003. "Incentive structures in institutional asset management and their implications for financial markets," CGFS Papers, Bank for International Settlements, number 21.
    12. Kaminsky, Graciela & Lyons, Richard K. & Schmukler, Sergio L., 2004. "Managers, investors, and crises: mutual fund strategies in emerging markets," Journal of International Economics, Elsevier, vol. 64(1), pages 113-134, October.
    13. Weder di Mauro, Beatrice & von Westernhagen, Natalja & Nestmann, Thorsten & Heid, Frank, 2005. "German Bank Lending During Financial Crises: A Bank Level Analysis," CEPR Discussion Papers 5164, C.E.P.R. Discussion Papers.
    14. Sophie Brana & Delphine Lahet, 2005. "La propagation des crises financieres dans les pays emergents : la contagion est-elle discriminante ?," Economie Internationale, CEPII research center, issue 103, pages 73-96.
    15. Radovan Vadovic, 2009. "Early, Late, and Multiple Bidding in Internet Auctions," Working Papers 0904, Centro de Investigacion Economica, ITAM.
    16. Gimet, Celine, 2007. "Conditions necessary for the sustainability of an emerging area: The importance of banking and financial regional criteria," Journal of Multinational Financial Management, Elsevier, vol. 17(4), pages 317-335, October.
    17. Marcel Fratzscher, 2003. "On currency crises and contagion," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 8(2), pages 109-129.
    18. Bayoumi, Tamim & Fazio, Giorgio & Kumar, Manmohan & MacDonald, Ronald, 2007. "Fatal attraction: Using distance to measure contagion in good times as well as bad," Review of Financial Economics, Elsevier, vol. 16(3), pages 259-273.
    19. Corsetti, Giancarlo & Pericoli, Marcello & Sbracia, Massimo, 2005. "'Some contagion, some interdependence': More pitfalls in tests of financial contagion," Journal of International Money and Finance, Elsevier, vol. 24(8), pages 1177-1199, December.
    20. Taylor, Mark & Mody, Ashoka, 2003. "Common Vulnerabilities," CEPR Discussion Papers 3759, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    WP; emerging market; mutual fund;
    All these keywords.

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:imf:imfwpa:2004/131. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Akshay Modi (email available below). General contact details of provider: https://edirc.repec.org/data/imfffus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.