Premium
A Rational Expectations Model of Financial Contagion
Author(s) -
Kodres Laura E.,
Pritsker Matthew
Publication year - 2002
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/1540-6261.00441
Subject(s) - financial contagion , rational expectations , economics , financial market , information asymmetry , asset (computer security) , monetary economics , capital asset pricing model , financial economics , finance , econometrics , computer security , computer science
We develop a multiple asset rational expectations model of asset prices to explain financial market contagion. Although the model allows contagion through several channels, our focus is on contagion through cross‐market rebalancing. Through this channel, investors transmit idiosyncratic shocks from one market to others by adjusting their portfolios' exposures to shared macroeconomic risks. The pattern and severity of financial contagion depends on markets' sensitivities to shared macroeconomic risk factors, and on the amount of information asymmetry in each market. The model can generate contagion in the absence of news, as well as between markets that do not directly share macroeconomic risks.