Financial Contagion and Attention Allocation

We explain financial contagion between two stock markets with uncorrelated fundamentals using fluctuations in international investors' attention allocation. We also show that the degree of (non)anticipation of a crisis is crucial for the existence of contagion. Using daily data on stock market prices and news stories in the Financial Times, we find evidence supporting the attention reallocation mechanism of financial contagion: The higher the price volatility of the Asian market, the more absolute and relative attention allocated to the Asian market, and the more relative attention allocated to the Asian market, the higher the price volatility of Latin American markets.