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leverage constraints and the international transmission of shocks

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  • James Yetman

    (Bank for International Settlements)

  • Michael B. Devereux

    (University of British Columbia)

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 financial institutions. In the absence of leverage constraints, international portfolio diversification has no implications for macro-economic co-movements. When leverage constraints bind, however, the presence of diversified portfolios in combination with these constraints introduces a powerful financial transmission channel which results in a high correlation among macroeconomic aggregates during business cycle downturns, quite independent of the size of international trade linkages. Conversely, the paper shows that, conditional on leverage constraints binding, international financial integration through equity markets reverses the sign of the international co-movement of shocks, leading co-movement to switch from negative to positive.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 1341.

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Date of creation: 2010
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Handle: RePEc:red:sed010:1341

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  1. Jonathan Heathcote & Fabrizio Perri, 2002. "Financial Globalization and Real Regionalization," NBER Working Papers 9292, National Bureau of Economic Research, Inc.
  2. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics, Boston College Department of Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
  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. 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.
  5. Imbs, Jean, 2003. "Trade, Finance, Specialization and Synchronization," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3779, C.E.P.R. Discussion Papers.
  6. Tille, Cédric & van Wincoop, Eric, 2010. "International capital flows," Journal of International Economics, Elsevier, vol. 80(2), pages 157-175, March.
  7. 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.
  8. Devereux, Michael B & Sutherland, Alan, 2007. "Country Portfolio Dynamics," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6208, C.E.P.R. Discussion Papers.
  9. Mendoza, Enrique G. & Smith, Katherine A., 2006. "Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices," Journal of International Economics, Elsevier, vol. 70(1), pages 82-114, September.
  10. Faia, Ester, 2007. "Finance and international business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 54(4), pages 1018-1034, May.
  11. Luca Dedola & Giovanni Lombardo, 2012. "Financial frictions, financial integration and the international propagation of shocks," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 27(70), pages 319-359, 04.
  12. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers, C.V. Starr Center for Applied Economics, New York University 98-03, C.V. Starr Center for Applied Economics, New York University.
  13. Imbs, Jean, 2004. "The Real Effects of Financial Integration," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4335, C.E.P.R. Discussion Papers.
  14. Michael B. Devereux & Alan Sutherland, 2008. "Country Portfolios in Open Economy Macro Models," NBER Working Papers 14372, National Bureau of Economic Research, Inc.
  15. Pavlova, Anna & Rigobon, Roberto, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6647, C.E.P.R. Discussion Papers.
  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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