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Financial contagion in the laboratory: The cross-market rebalancing channel

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  • Cipriani, Marco
  • Gardenal, Gloria
  • Guarino, Antonio

Abstract

We present the results of the first experimental study of financial markets contagion. We develop a model of financial contagion amenable to be tested in the laboratory. In the model, contagion happens because of cross-market rebalancing, a channel for transmission of shocks across markets first studied by Kodres and Pritsker (2002). Theory predicts that, because of portfolio rebalancing, a negative shock in one market transmits itself to the others, as investors adjust their portfolio allocations. The theory is supported by the experimental results. The price observed in the laboratory is close to that predicted by theory, and strong contagion effects are observed. The results are robust across different market structures. Moreover, as theory predicts, lower asymmetric information in a (“developed”) financial market increases the contagion effects in (“emerging”) markets.

Suggested Citation

  • Cipriani, Marco & Gardenal, Gloria & Guarino, Antonio, 2013. "Financial contagion in the laboratory: The cross-market rebalancing channel," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4310-4326.
    • Handle: RePEc:eee:jbfina:v:37:y:2013:i:11:p:4310-4326
    DOI: 10.1016/j.jbankfin.2013.06.005
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    References listed on IDEAS

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    1. King, Mervyn A & Wadhwani, Sushil, 1990. "Transmission of Volatility between Stock Markets," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 5-33.
    2. 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.
    3. Cipriani Marco & Guarino Antonio, 2008. "Herd Behavior and Contagion in Financial Markets," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 8(1), pages 1-56, October.
    4. Plott, Charles R. & Gray, Peter, 1990. "The multiple unit double auction," Journal of Economic Behavior & Organization, Elsevier, vol. 13(2), pages 245-258, March.
    5. 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.
    6. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, vol. 98(4), pages 1211-1244, September.
    7. Albert S. Kyle, 2001. "Contagion as a Wealth Effect," Journal of Finance, American Finance Association, vol. 56(4), pages 1401-1440, August.
    8. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer;Economic Science Association, vol. 10(2), pages 171-178, June.
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    Cited by:

    1. Pragidis, I.C. & Aielli, G.P. & Chionis, D. & Schizas, P., 2015. "Contagion effects during financial crisis: Evidence from the Greek sovereign bonds market," Journal of Financial Stability, Elsevier, vol. 18(C), pages 127-138.

    More about this item

    Keywords

    Financial contagion; Rebalancing channel; Laboratory experiment;

    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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