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Relative risk aversion and the transmission of financial crises

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  • Boschi, Melisso
  • Goenka, Aditya

Abstract

We study how investor behavior affects the transmission of financial crises. If investors exhibit decreasing relative risk aversion, then negative wealth shocks increase the risk premium required to hold risky assets. We integrate this into a second generation model of currency crises which allows for contagion through changes in fundamentals. Investor behavior can be a transmission channel of financial crises, as changes in risk premia increase the coverage ratio and makes the defense of a peg less attractive for the policy maker. The feedback effect of the risk premia on the probability of devaluation also makes multiple equilibria more likely. The possible stabilization effects of capital controls and a Tobin tax on the international transmission of financial crises are also studied.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 36 (2012)
Issue (Month): 1 ()
Pages: 85-99

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Handle: RePEc:eee:dyncon:v:36:y:2012:i:1:p:85-99

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Web page: http://www.elsevier.com/locate/jedc

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Keywords: Financial crises; Contagion; International asset pricing; Relative risk aversion; Wealth effects; Capital controls; Tobin tax;

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Cited by:
  1. M Boschi & S d'Addona & A Goenka, 2012. "Testing external habits in an asset pricing model," CAMA Working Papers 2012-20, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  2. Melisso Boschi & Stefano d'Addona & Aditya Goenka, 2009. "Testing Habits In An Asset Pricing Model," Working Papers 0509, CREI Università degli Studi Roma Tre, revised 2009.

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