Information acquisition and financial contagion

Abstract

This paper incorporates costly voluntary acquisition of information à la Nikitin and Smith (2007) (2000) [Allen, F., Gale, D., 2000. Financial contagion. Journal of Political Economy 108, 1 33], without relying on any unexpected shock to model contagion. In this framework, contagion and financial crises are the result of information gathering by depositors, weak fundamentals and an incomplete market structure of banks. It also shows how financial systems entering a recession can affect others with apparently stronger economic conditions (contagion). Finally, this is the first paper to investigate the effectiveness of the Contingent Credit Line procedures, introduced by the IMF at the end of the nineties, as a mechanism to prevent the propagation of crises. Ó JEL classification: G21; D82

Is gold a safe haven? International evidence

“…International diversification is made possible by the less than perfect integration of international stock markets (Bai and Green, 2010;Chandar et al, 2009;Francis et al, 2008). However, in times of financial crisis, contagion effects may cause markets to co-move strongly, even where macroeconomic fundamentals would not suggest strong interdependence (Dornbusch et al, 2000;Hasman and Samartin, 2008). Thus there would appear to be limits to the potential for international diversification to reduce risks for investors (see also Ibragimov and Walden, 2007).…”

Bank-specific shocks and the real economy

“…A third related strand of literature deals with the transmission of shocks within the financial system (Hasman andSamartín 2008, Allen andGale 2007). Allen and Gale (2000) describe how interbank linkages can lead to contagion although a shock first occurs in only one bank.…”

Unobservable shocks as carriers of contagion

“…3 Network theory proposes optimal degrees of connectedness between financial institutions, where both the number of connections and the form of those connections -whether to the centre or periphery institutions -matters. (See Allen and Gale (2000) for the seminal contribution but also Freixas et al (2000), Hasman and Samartín (2008), and for empirical evidence, Furfine (2003). )…”