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Relative risk aversion and the transmission of financial crises

Melisso Boschi () and Aditya Goenka ()

Journal of Economic Dynamics and Control, 2012, vol. 36, issue 1, 85-99

Abstract: We study how investor behavior affects the transmission of financial crises. If investors exhibit decreasing relative risk aversion, then negative wealth shocks increase the risk premium required to hold risky assets. We integrate this into a second generation model of currency crises which allows for contagion through changes in fundamentals. Investor behavior can be a transmission channel of financial crises, as changes in risk premia increase the coverage ratio and makes the defense of a peg less attractive for the policy maker. The feedback effect of the risk premia on the probability of devaluation also makes multiple equilibria more likely. The possible stabilization effects of capital controls and a Tobin tax on the international transmission of financial crises are also studied.

Keywords: Financial crises; Contagion; International asset pricing; Relative risk aversion; Wealth effects; Capital controls; Tobin tax (search for similar items in EconPapers)
JEL-codes: D91 E44 F31 F32 G11 G12 G15 (search for similar items in EconPapers)
Date: 2012
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Working Paper: RELATIVE RISK AVERSION AND THE TRANSMISSION OF FINANCIAL CRISES (2007) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:36:y:2012:i:1:p:85-99

DOI: 10.1016/j.jedc.2011.07.005

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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