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Financial Contagion and Attention Allocation

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Author Info
Jordi Mondria () (Princeton University)

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Abstract

This paper explains financial contagion between two independent stock markets by fluctuations in international investors' attention allocation. I model the process of attention allocation that underlies portfolio investment in international markets using rationally inattentive agents. Investors optimally allocate more attention to a region hit by a financial crisis, to the detriment of other markets. The resulting endogenous increase in uncertainty causes the risk premium on all risky assets to rise. Hence, stock prices around the world collapse and there is a flight to quality. I show that the degree of (non)anticipation of a crisis is crucial for the existence of contagion. Using Financial Times coverage as a proxy for attention allocation, I find strong support for the model's predictions

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 177.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:177

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Related research
Keywords: Financial Contagion; Emerging Markets; Rational Inattention;

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Find related papers by JEL classification:
F30 - International Economics - - International Finance - - - General
D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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References listed on IDEAS
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.:
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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. Tutino, Antonella, 2008. "The rigidity of choice: lifetime savings under information-processing constraints," MPRA Paper 16744, University Library of Munich, Germany, revised 24 Jul 2009. [Downloadable!]
  2. Antonella Tutino, 2008. "The rigidity of choice: Lifecycle savings with information-processing limits," Finance and Economics Discussion Series 2008-62, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  3. Yulei Luo, 2006. "Rational Inattention, Portfolio Choice, and the Equity Premium," Computing in Economics and Finance 2006 56, Society for Computational Economics. [Downloadable!]
  4. Mackowiak, Bartosz Adam & Wiederholt, Mirko, 2007. "Optimal Sticky Prices under Rational Inattention," CEPR Discussion Papers 6243, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  5. Jordi Mondria & Thomas Wu & Yi Zhang, 2008. "The Determinants of International Investment and Attention Allocation: Using Internet Search Query Data," Working Papers tecipa-326, University of Toronto, Department of Economics. [Downloadable!]
  6. Christopher A. Sims, 2006. "Rational Inattention: Beyond the Linear-Quadratic Case," American Economic Review, American Economic Association, vol. 96(2), pages 158-163, May. [Downloadable!]
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