The Journal of Finance

Asymmetric Price Movements and Borrowing Constraints: A Rational Expectations Equilibrium Model of Crises, Contagion, and Confusion

Published: 07/20/2005   |   DOI: 10.1111/j.1540-6261.2005.00733.x

KATHY YUAN

This study proposes a rational expectations equilibrium model of crises and contagion in an economy with information asymmetry and borrowing constraints. Consistent with empirical observations, the model finds: (1) Crises can be caused by small shocks to fundamentals; (2) market return distributions are asymmetric; and (3) correlations among asset returns tend to increase during crashes. The model also predicts: (1) Crises and contagion are likely to occur after small shocks in the intermediate price region; (2) the skewness of asset price distributions increases with information asymmetry and borrowing constraints; and (3) crises can spread through investor borrowing constraints.

Feedback Effects and Asset Prices

Published: 07/19/2008   |   DOI: 10.1111/j.1540-6261.2008.01378.x

EMRE OZDENOREN, KATHY YUAN

Feedback effects from asset prices to firm cash flows have been empirically documented. This finding raises a question for asset pricing: How are asset prices determined if price affects fundamental value, which in turn affects price? In this environment, by buying assets that others are buying, investors ensure high future cash flows for the firm and subsequent high returns for themselves. Hence, investors have an incentive to coordinate, which may generate self‐fulfilling beliefs and multiple equilibria. Using insights from global games, we pin down investors' beliefs, analyze equilibrium prices, and show that strong feedback leads to higher excess volatility.

How Do Crises Spread? Evidence from Accessible and Inaccessible Stock Indices

Published: 03/09/2006   |   DOI: 10.1111/j.1540-6261.2006.00860.x

BRIAN H. BOYER, TOMOMI KUMAGAI, KATHY YUAN

We provide empirical evidence that stock market crises are spread globally through asset holdings of international investors. By separating emerging market stocks into two categories, namely, those that are eligible for purchase by foreigners (accessible) and those that are not (inaccessible), we estimate and compare the degree to which accessible and inaccessible stock index returns co‐move with crisis country index returns. Our results show greater co‐movement during high volatility periods, especially for accessible stock index returns, suggesting that crises spread through the asset holdings of international investors rather than through changes in fundamentals.