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Leverage Constraints and the International Transmission of Shocks

  • Michael B Devereux

    (University of British Columbia)

  • James Yetman

    (Bank for International Settlements)

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 macroeconomic 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.

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Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2009-08.

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Date of creation: Dec 2009
Date of revision:
Handle: RePEc:rba:rbardp:rdp2009-08
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  1. Jean Imbs, 2003. "Trade, Finance, Specialization, and Synchronization," IMF Working Papers 03/81, International Monetary Fund.
  2. Jean Imbs, 2006. "The Real Effects of Financial Integration," Post-Print hal-00612566, HAL.
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  8. Alan Sutherland & Michael B. Devereux, 2007. "Country Portfolio Dynamics," IMF Working Papers 07/283, International Monetary Fund.
  9. Faia, Ester, 2007. "Finance and international business cycles," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1018-1034, May.
  10. 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.
  11. 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.
  12. Luca Dedola & Giovanni Lombardo, 2012. "Financial frictions, financial integration and the international propagation of shocks," Economic Policy, CEPR;CES;MSH, vol. 27(70), pages 319-359, 04.
  13. Cordoba, Juan Carlos & Ripoll, Marla, 2010. "Credit Cycles Redux," Staff General Research Papers 32122, Iowa State University, Department of Economics.
    • 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.
  14. Heathcote, Jonathan & Perri, Fabrizio, 1999. "Financial Autarky and International Business Cycles," SSE/EFI Working Paper Series in Economics and Finance 320, Stockholm School of Economics, revised 30 Apr 2000.
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  16. repec:bla:restud:v:75:y:2008:i:4:p:1215-1256 is not listed on IDEAS
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