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Leverage Constraints and the International Transmission of Shocks

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  • Michael B. Devereux
  • James Yetman

Abstract

Recent macroeconomic experience has drawn attention to the importance of interdependence among countries through financial markets and institutions, independently of traditional trade linkages. This paper develops a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained investors. In our model, without leverage constraints on investment, financial integration itself has no implication for international macro co-movements. When leverage constraints bind however, the presence of these constraints in combination with diversified portfolios introduces a powerful financial transmission channel which results in a positive co-movement of production, independently of the size of international trade linkages. In addition, the paper shows that, with binding leverage constraints, the type of financial integration is critical for international co-movement. If international financial markets allow for trade only in non-contingent bonds, but not equities, then the international co-movement of shocks is negative. Thus, with leverage constraints, moving from bond trade to equity trade reverses the sign of the international transmission of shocks.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16226.

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Date of creation: Jul 2010
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Publication status: published as Michael B. Devereux & James Yetman, 2010. "Leverage Constraints and the International Transmission of Shocks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 71-105, 09.
Handle: RePEc:nbr:nberwo:16226

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  1. Devereux, Michael B. & Sutherland, Alan, 2010. "Country portfolio dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 34(7), pages 1325-1342, July.
  2. Jonathan Heathcote & Fabrizio Perri, 2002. "Financial Globalization and Real Regionalization," NBER Working Papers 9292, National Bureau of Economic Research, Inc.
  3. Juan-Carlos Cordoba & Marla Ripoll, 2004. "Credit Cycles Redux," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(4), pages 1011-1046, November.
  4. Jean Imbs, 2003. "Trade, Finance, Specialization, and Synchronization," IMF Working Papers 03/81, International Monetary Fund.
  5. Enrique G. Mendoza & Katherine A. Smith, 2004. "Quantitative Implication of A Debt-Deflation Theory of Sudden Stops and Asset Prices," NBER Working Papers 10940, National Bureau of Economic Research, Inc.
  6. Cedric Tille & Eric van Wincoop, 2007. "International Capital Flows," Working Papers 122007, Hong Kong Institute for Monetary Research.
  7. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
  8. Giovanni Lombardo & Luca Dedola, 2010. "Financial Frictions, Financial Integration and the International Propagation of Shocks," 2010 Meeting Papers 288, Society for Economic Dynamics.
  9. Pavlova, Anna & Rigobon, Roberto, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," CEPR Discussion Papers 6647, C.E.P.R. Discussion Papers.
  10. Imbs, Jean, 2006. "The real effects of financial integration," Journal of International Economics, Elsevier, vol. 68(2), pages 296-324, March.
  11. Michael B. Devereux & Alan Sutherland, 2008. "Country portfolios in open economy macro models," Globalization and Monetary Policy Institute Working Paper 09, Federal Reserve Bank of Dallas.
  12. Heathcote, Jonathan & Perri, Fabrizio, 1999. "Financial Autarky and International Business Cycles," Working Paper Series in Economics and Finance 320, Stockholm School of Economics, revised 30 Apr 2000.
  13. Faia, Ester, 2007. "Finance and international business cycles," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1018-1034, May.
  14. Baxter, Marianne & Jermann, Urban J, 1997. "The International Diversification Puzzle Is Worse Than You Think," American Economic Review, American Economic Association, vol. 87(1), pages 170-80, March.
  15. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  16. repec:bla:restud:v:75:y:2008:i:4:p:1215-1256 is not listed on IDEAS
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  1. Leverage Constraints and the International Transmission of Shocks
    by Martin Berka in NEP-OPM blog on 2010-05-02 22:03:47
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