IMF Working Papers

Portfolio Diversification, Leverage, and Financial Contagion

By T. Todd Smith, Garry J. Schinasi

October 1, 1999

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T. Todd Smith, and Garry J. Schinasi Portfolio Diversification, Leverage, and Financial Contagion, (USA: International Monetary Fund, 1999) accessed October 7, 2024
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.

Subject: Econometric analysis, Financial contagion, Financial institutions, Financial markets, Financial sector policy and analysis, National accounts, Personal income, Securities markets, Stocks, Vector autoregression

Keywords: Asia and Pacific, Asset position, B. portfolio management, Conditional asset return distribution, Current-period portfolio allocation problem of a portfolio manager, Financial contagion, Leverage, Leveraged portfolio, Management rule, Margin call, Personal income, Portfolio choice, Portfolio management rule, Portfolio manager, Return distribution, Risky assets, Securities markets, Stocks, Vector autoregression, WP

Publication Details

  • Pages:

    38

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 1999/136

  • Stock No:

    WPIEA1361999

  • ISBN:

    9781451855791

  • ISSN:

    1018-5941

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