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Contagion of self-fulfilling financial crises due to diversification of investment portfolios. (English) Zbl 1080.91032

Summary: We look at two countries that have independent fundamentals, but share the same group of investors. Each country might face a self-fulfilling crisis: Agents withdrawing their investments fearing that others will. A crisis in one country reduces agents’ wealth. This makes them more averse to the strategic risk associated with the unknown behavior of other agents in the second country, increasing their incentive to withdraw their investments. Consequently, the probability of a crisis there increases. This generates a positive correlation between the returns in the two countries. Since diversification affects returns in our model, its welfare implications are non-trivial.

MSC:

91G10 Portfolio theory
91B64 Macroeconomic theory (monetary models, models of taxation)
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