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Financial Contagion and Attention Allocation

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  • Jordi Mondria

    () (Princeton University)

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

Suggested Citation

  • Jordi Mondria, 2006. "Financial Contagion and Attention Allocation," 2006 Meeting Papers 177, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:177
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    More about this item

    Keywords

    Financial Contagion; Emerging Markets; Rational Inattention;

    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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