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Role of portfolio constraints in the international propagation of shocks

Subject

Finance

Publishing details

Review of Economic Studies

Authors / Editors

Pavlova A;Rigobon R

Biographies

Anna Pavlova

Publication Year

2008

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; Exchange rate; Terms of trade; Wealth transfer; Portfolio constraints; Contagion; International transmission

Publication Notes

Published in the Review of Economic Studies

Publication Research Centre

Institute of Finance and Accounting

Series Number

72

Series

Review of Economic Studies

Available on ECCH

No


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