Recent crises have seen very large spikes in asset price risk without dramatic shifts in fundamentals. We propose an explanation for these risk panics based on self-fulfilling shifts in risk made possible by a negative link between the current asset price and risk about the future asset price....

There has been a long debate about whether speculators are stabilizing or not. We consider a model where speculators have a stabilizing role in normal times, but may also provoke large risk panics. The very feature that makes arbitrageurs liquidity providers in normal times, namely their...

While the 2008-2009 fi nancial crisis originated in the United States, we witnessed steep declines in output, consumption and investment of similar magnitudes around the globe. This raises two questions. First, given the observed strong home bias in goods and fi nancial markets, what can account...

Recently portfolio choice has become an important element of many DSGE open economy models. Yet, a substantial body of evidence is inconsistent with standard frictionless portfolio choice models. In this paper we introduce a quadratic cost of changes in portfolio allocation into a two-country...

We introduce a portfolio friction in a two-country DSGE model where investors face a constant probability to make new portfolio decisions. The friction leads to a more gradual portfolio adjustment to shocks and a weaker portfolio response to changes in expected excess returns. We apply the model...

The objective of this paper is to show that the proposal by Froot and Thaler (1990) of delayed portfolio adjustment can account for a broad set of puzzles about the relationship between interest rates and exchange rates. The puzzles include: i) the delayed overshooting puzzle; ii) the forward...

Modern open economy macro models assume the continuous adjustment of international portfolio allocation. We introduce gradual portfolio adjustment into a global equity market model. Our approach differs from related literature in two key dimensions. First, the time interval between portfolio...