Portfolio Diversification, Leverage, and Financial Contagion

Author/Editor:

T. Todd Smith ; Garry J. Schinasi

Publication Date:

October 1, 1999

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

Models of “contagion” rely on market imperfections to explain why adverse shocks in one asset market might be associated with asset sales in many unrelated markets. This paper demonstrates that contagion can be explained with basic portfolio theory without recourse to market imperfections. It also demonstrates that “Value-at-Risk” portfolio management rules do not have significantly different consequences for portfolio rebalancing and contagion than other rules. The paper’s main conclusion is that portfolio diversification and leverage may be sufficient to explain why investors would find it optimal to sell many higher-risk assets when a shock to one asset occurs.

Series:

Working Paper No. 99/136

English

Publication Date:

October 1, 1999

ISBN/ISSN:

9781451855791/1018-5941

Stock No:

WPIEA1361999

Price:

$15.00 (Academic Rate:$15.00)

Format:

Paper

Pages:

38

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