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Fluctuating attention and financial contagion

Michael Hasler and Chayawat Ornthanalai

Journal of Monetary Economics, 2018, vol. 99, issue C, 106-123

Abstract: Financial contagion occurs when return and volatility transmit between fundamentally unrelated sectors. Our equilibrium model shows that contagion arises because investors pay fluctuating attention to news. As a negative shock hits one sector, investors pay more attention to it. This raises the volatility of equilibrium discount rates resulting in simultaneous spikes in cross-sector correlations and volatilities. We test the economic mechanism of the model on fundamentally unrelated U.S. industries, which are identified using their customer-supplier relationships. Consistent with the model’s predictions, empirical evidence shows that fluctuating attention generates return and volatility spillovers between fundamentally unrelated industries.

Keywords: Learning; Attention to news; Contagion; Return and volatility spillovers (search for similar items in EconPapers)
JEL-codes: D51 G12 (search for similar items in EconPapers)
Date: 2018
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