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Managerial Incentives and Financial Contagion

  • Sujit Chakravorti

    (Federal Reserve Bank of Chicago)

  • Subir Lall

    (International Monetary Fund)

This paper proposes a framework for comovements of asset prices with seemingly unrelated fundamentals, as an outcome of optimal portfolio strategies by fund managers. In emerging markets, dedicated managers outperforming a benchmark index and global managers maximizing absolute returns lead to systematic interactions between asset prices, without asymmetric information. The model determines optimal portfolio weights, the incidence of relative value strategies, and prices systematically deviating from fundamentals with limits to arbitraging this differential. Managerial compensation contracts, optimal at the firm level, may lead to inefficiencies at the macroeconomic level. We identify conditions when shocks in one emerging market affect others.

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File URL: http://econwpa.repec.org/eps/if/papers/0408/0408003.pdf
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Paper provided by EconWPA in its series International Finance with number 0408003.

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Length: 47 pages
Date of creation: 16 Aug 2004
Date of revision:
Handle: RePEc:wpa:wuwpif:0408003
Note: Type of Document - pdf; pages: 47
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
  2. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June.
  3. Reinhart, Carmen & Calvo, Sara, 1996. "Capital Flows to Latin America: Is There Evidence of Contagion Effects?”," MPRA Paper 7124, University Library of Munich, Germany.
  4. Kaminsky, Graciela L. & Schmukler, Sergio L., 1999. "What triggers market jitters? A chronicle of the Asian crisis," Policy Research Working Paper Series 2094, The World Bank.
  5. Guillermo A. Calvo & Enrique G. Mendoza, 1999. "Regional Contagion and the Globalization of Securities Markets," NBER Working Papers 7153, National Bureau of Economic Research, Inc.
  6. Albert S. Kyle, 2001. "Contagion as a Wealth Effect," Journal of Finance, American Finance Association, vol. 56(4), pages 1401-1440, 08.
  7. 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, 04.
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