Regional Contagion and the Globalization of Securities Markets

This paper argues that the globalization of securities markets may promote contagion among investors by weakening incentives for gathering costly country-specific information and by strengthening incentives for imitating arbitrary market portfolios. In the presence of short-selling constraints, the utility gain of gathering information at a fixed cost converges to a constant level and may diminish as securities markets grow. Moreover, if a portfolio manager's marginal cost for yielding below-market returns exceeds the marginal gain for above-market returns, there is a range of optimal portfolios in which all investors imitate arbitrary market portfolios and this range widens as the market grows. Numerical simulations suggest that these frictions can have significant quantitative implications and they may induce large capital flows in emerging markets.

[1]  D The Gains from International Risk-Sharing , 2001 .

[2]  S. Aiyagari,et al.  "Overreaction" of Asset Prices in General Equilibrium , 1998 .

[3]  M. King,et al.  The debt burden and its consequences for monetary policy : proceedings of a conference held by the International Economic Association at the Deutsche Bundesbank, Frankfurt, Germany , 1998 .

[4]  E. Mendoza.  Terms-of-trade uncertainty and economic growth , 1997 .

[5]  G. Calvo,et al.  Reflections on Mexico''s Balance of Payments Crisis: A Chronicle of a Death Foretold , 1996 .

[6]  Sergio L. Schmukler,et al.  Country Fund Discounts, Asymmetric Information and the Mexican Crisis of 1994: Did Local Residents Turn Pessimistic Before International Investors? , 1996 .

[7]  Carmen M. Reinhart,et al.  Capital Flows to Latin America: Is There Evidence of Contagion Effects? , 1996 .

[8]  Campbell R. Harvey,et al.  Expected Returns and Volatility in 135 Countries , 1996 .

[9]  G. Calvo.  Varieties of Capital-Market Crises , 1995 .

[10]  R. Shiller.  Conversation, Information, and Herd Behavior , 1995 .

[11]  Ingrid M. Werner,et al.  U.S. Equity Investment in Emerging Stock Markets , 1995 .

[12]  A. Banerjee,et al.  A Simple Model of Herd Behavior , 1992 .

[13]  M. Obstfeld.  Risk-Taking, Global Diversification, and Growth , 1992 .

[14]  S. Bikhchandani,et al.  You have printed the following article : A Theory of Fads , Fashion , Custom , and Cultural Change as Informational Cascades , 2007 .

[15]  E. Mendoza.  Capital Controls and the Gains from Trade in a Business Cycle Model of a Small Open Economy , 1991 .

[16]  D. Scharfstein,et al.  Herd Behavior and Investment , 1990 .

[17]  R. Shiller,et al.  Are Institutional Investors Speculators? , 1987 .

[18]  R. Shiller,et al.  Survey Evidence on Diffusion of Investment Among Institutional Investors , 1986 .

[19]  Sanford J. Grossman.  On the Impossibility of Informationally Efficient Markets , 1980 .

[20]  Sanford J. Grossman,et al.  Information and Competitive Price Systems , 1976 .

[21]  J. Keynes.  GENERAL THEORY OF EMPLOYMENT INTEREST. , 1961 .

[22]  J. Keynes.  The General Theory of Employment , 1937 .

[23]  H. Barger.  The General Theory of Employment, Interest and Money , 1936, Nature.