Portfolio Diversification, Leverage, and Financial Contagion

T. Smith and Garry Schinasi ()

No 1999/136, IMF Working Papers from International Monetary Fund

Abstract: Models of “contagion” rely on market imperfections to explain why adverse shocks in one asset market might be associated with asset sales in many unrelated markets. This paper demonstrates that contagion can be explained with basic portfolio theory without recourse to market imperfections. It also demonstrates that “Value-at-Risk” portfolio management rules do not have significantly different consequences for portfolio rebalancing and contagion than other rules. The paper’s main conclusion is that portfolio diversification and leverage may be sufficient to explain why investors would find it optimal to sell many higher-risk assets when a shock to one asset occurs.

Keywords: WP; management rule; asset position; margin call; financial contagion; portfolio choice; leverage; portfolio management rule; risky assets; portfolio manager; return distribution; leveraged portfolio; conditional asset return distribution; current-period portfolio allocation problem of a portfolio manager; B. portfolio management; Vector autoregression; Personal income; Stocks; Securities markets; Asia and Pacific (search for similar items in EconPapers)
Pages: 38
Date: 1999-10-01
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Citations: View citations in EconPapers (41)

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Journal Article: Portfolio Diversification, Leverage, and Financial Contagion (2000)
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