Financial Contagion and Attention Allocation

Jordi Mondria ()

No 177, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: This paper explains financial contagion between two independent stock markets by fluctuations in international investors' attention allocation. I model the process of attention allocation that underlies portfolio investment in international markets using rationally inattentive agents. Investors optimally allocate more attention to a region hit by a financial crisis, to the detriment of other markets. The resulting endogenous increase in uncertainty causes the risk premium on all risky assets to rise. Hence, stock prices around the world collapse and there is a flight to quality. I show that the degree of (non)anticipation of a crisis is crucial for the existence of contagion. Using Financial Times coverage as a proxy for attention allocation, I find strong support for the model's predictions

Keywords: Financial Contagion; Emerging Markets; Rational Inattention (search for similar items in EconPapers)
JEL-codes: D80 F30 G10 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (13)

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Related works:
Journal Article: Financial Contagion and Attention Allocation (2013)
Working Paper: Financial contagion and attention allocation (2012)
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