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Cheap But Flighty: How Global Imbalances Create Financial Fragility

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  • Toni Ahnert
  • Enrico Perotti

Abstract

We analyze how a wealth shift to emerging countries may lead to instability in developed countries. Investors exposed to expropriation risk are willing to pay a safety premium to invest in countries with good property rights. Domestic intermediaries compete for such cheap funding by carving out safe claims, which requires demandable debt. While foreign inflows allow countries to expand their domestic credit, risk-intolerant foreign investors withdraw even under minimal uncertainty. We show that more foreign funding causes larger and more frequent runs. Beyond some scale, even risk-tolerant domestic investors are induced to withdraw to avoid dilution. As excess liquidation causes social losses, a domestic planner may seek prudential measures on the scale of foreign inflows.

Suggested Citation

  • Toni Ahnert & Enrico Perotti, 2015. "Cheap But Flighty: How Global Imbalances Create Financial Fragility," Staff Working Papers 15-33, Bank of Canada.
  • Handle: RePEc:bca:bocawp:15-33
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    References listed on IDEAS

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    Cited by:

    1. Matta, Rafael & Perotti, Enrico C, 2015. "Insecure Debt," CEPR Discussion Papers 10505, C.E.P.R. Discussion Papers.
    2. Ahnert, Toni & Anand, Kartik & Gai, Prasanna & Chapman, James, 2015. "Safe, or not safe? Covered bonds and Bank Fragility," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 112875, Verein für Socialpolitik / German Economic Association.
    3. Toni Ahnert & Benjamin Nelson, 2016. "Opaque Assets and Rollover Risk," Staff Working Papers 16-17, Bank of Canada.
    4. Golec, Pascal & Perotti, Enrico, 2017. "Safe assets: a review," Working Paper Series 2035, European Central Bank.

    More about this item

    Keywords

    Financial stability; Financial institutions;

    JEL classification:

    • F3 - International Economics - - International Finance
    • G2 - Financial Economics - - Financial Institutions and Services

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