financial contagion and asset price dynamics

R. Andergassen

Working Papers from Dipartimento Scienze Economiche, Universita' di Bologna

Abstract: Recent literature shows how the destabilising effect of portfolio insurance activity on the price of the underlying asset depends on the liquidity of the asset market. We build a simple model where market timers shift capital around asset markets in order to exploit gains from temporary excess-volatility of asset prices. In this way, market timers increase the liquidity of asset markets reducing the excess volatility, while they increase the cross-market correlation, whereas long-ranged financial contagion eventually occurs. We show how liquidity of asset markets, cross-market correlation and excess volatility of asset prices depend on structural parameters of asset markets.

Date: 2002
New Economics Papers: this item is included in nep-fmk and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:bol:bodewp:448

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