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Author:Broner, Fernando 

Working Paper
When in peril, retrench: testing the portfolio channel of contagion
One plausible mechanism through which financial market shocks may propagate across countries is through the effect of past gains and losses on investors? risk aversion. The paper first presents a simple model examining how heterogeneous changes in investors? risk aversion affects portfolio decisions and stock prices. Second, the paper shows empirically that, when funds? returns are below average, they adjust their holdings toward the average (or benchmark) portfolio. In other words, they tend to sell the assets of countries in which they were ?overweight?, increasing their exposure to countries in which they were ?underweight.? Based on this insight, the paper discusses a matrix of financial interdependence reflecting the extent to which countries share overexposed funds. Comparing this measure to indices of trade or bank linkages indicates that our index can improve predictions about which countries are likely to be affected by contagion from crisis centers.
AUTHORS: Broner, Fernando; Gelos, Gaston; Reinhart, Carmen M.
DATE: 2004

Conference Paper
When in peril, retrench: testing the portfolio channel of contagion
It has frequently been argued that portfolio adjustments by international investors may transmit financial shocks across markets and borders. This notion, however, has not yet been examined with microeconomic data. One plausible mechanism through which shocks may propagate is through the effect of past gains and losses on investors? risk aversion. We test this hypothesis using a unique data set of the monthly country asset allocation of individual emerging market funds. We first present a simple model that analyzes the effect of heterogeneous changes in investors? risk aversion on portfolio decisions and stock prices. We then present empirical results that show that, consistent with the model, when funds? returns are relatively low compared to those of other funds, they adjust their holdings toward the average (or benchmark) portfolio. In other words, they tend to sell the assets of countries in which they were "overweight" and increase their exposure to countries in which they were "underweight." Building on this insight, we construct a matrix of financial interdependence reflecting the extent to which countries share a set of overexposed funds. Comparing this measure to indices of trade or bank linkages indicates that our index can improve predictions about which countries are likely to be affected by contagion from crisis centers.
AUTHORS: Broner, Fernando; Reinhart, Carmen M.; Gelos, Gaston
DATE: 2004-06

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