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Wealth Transfers, Contagion and Portfolio Constraints

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  • Pavlova, Anna
  • Rigobon, Roberto

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

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References

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Citations

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Cited by:
  1. Berrada, Tony & Hugonnier, Julien & Rindisbacher, Marcel, 2007. "Heterogeneous preferences and equilibrium trading volume," Journal of Financial Economics, Elsevier, vol. 83(3), pages 719-750, March.
  2. Pavlova, Anna & Rigobon, Roberto, 2004. "Asset Prices and Exchange Rates," Working papers 4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  3. Broner, Fernando A. & Lorenzoni, Guido & Schmukler, Sergio L., 2004. "Why do emerging economies borrow short term?," Policy Research Working Paper Series 3389, The World Bank.
  4. 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.
  5. 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.
  6. Pavlova, Anna & Rigobon, Roberto, 2010. "An asset-pricing view of external adjustment," Journal of International Economics, Elsevier, vol. 80(1), pages 144-156, January.
  7. Basak, Suleyman & Cass, David & Licari, Juan Manuel & Pavlova, Anna, 2008. "Multiplicity in general financial equilibrium with portfolio constraints," Journal of Economic Theory, Elsevier, vol. 142(1), pages 100-127, September.
  8. Stavros Panageas, 2009. "Bailouts, the Incentive to Manage Risk, and Financial Crises," NBER Working Papers 15058, National Bureau of Economic Research, Inc.

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