The Role of Portfolio Constraints in the International Propagation of Shocks

Roberto Rigobon and Anna Pavlova

No 6647, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study the comovement among stock prices and among exchange rates in a three-good three-country Centre-Periphery dynamic equilibrium model in which the Centre?s agents face portfolio constraints. We characterize equilibrium in closed form for a broad class of portfolio constraints, solving for stock prices, terms of trade, and portfolio holdings. We show that portfolio constraints generate wealth transfers between the Periphery countries and the Centre, which increase the comovement of the stock prices across the Periphery. We associate this excess comovement caused by portfolio constraints with the phenomenon known as contagion. The model generates predictions consistent with other important empirical results such as amplification and flight-to-quality effects.

Keywords: Asset pricing; Contagion; International finance; Portfolio constraints; Terms of trade; Wealth transfer (search for similar items in EconPapers)
JEL-codes: F31 F36 G12 G15 (search for similar items in EconPapers)
Date: 2008-01
New Economics Papers: this item is included in nep-cba and nep-dge
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Citations: View citations in EconPapers (111)

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Journal Article: The Role of Portfolio Constraints in the International Propagation of Shocks (2008)
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