Granular Expectation Shocks and International Financial Contagion

Résumé

Using a unique dataset linking investors’ cross-country GDP growth expectations to their investments into mutual funds and to the mutual funds’ cross-country allocation, we show that, while the flows into the funds are sensitive to the investors’ fund-specific aggregate expectations (computed using the fund’s portfolio shares), the funds’ allocation reacts less to the country-level expectations. This gives rise to “co-ownership spillovers”, whereby negative expectations about a country in which a fund invests can adversely affect capital flows to the other countries that are part of the fund’s portfolio. Using a portfolio choice model with delegated investment, we show that these results arise naturally from a sticky portfolio friction. These spillovers matter in the aggregate only if the portfolio shares are granular. Finally, using our data-based estimates and our model, we quantify the aggregate implications of these spillovers and find that co-ownership spillovers account for one fifth of the expectation-driven capital flows while country-specific expectations account for a negligible share. Small countries are subject to larger co-ownership spillovers, which account for one third of their expectation-driven capital flows, while large countries are the biggest contributors to these spillovers.