Duke Economics Working Paper #97-26
This paper shows that globalization of securities markets exacerbates the volatility of capital flows by strengthening incentives for herding behavior. This is a prediction of a mean-variance portfolio optimization model with imperfect information, in which investors acquire country-specific expertise at a fixed cost and incur variable reputational costs. The model produces equilibria in which incentives to confirm rumors decrease with globalization. Simulations based on equity markets data and country credit ratings suggest that herd behavior can induce large capital outflows from emerging markets.
Keywords: Herd behavior, contagion, capital mobility, international portfolio diversification
JEL: F30, F34, F36, G11, G15
Published as "Rational Contagion and the Globalization of Securities Markets" in Journal of International Economics, Vol. 51, No. 1, June 2000, pp. 79-113.