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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
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Handle: RePEc:rba:rbardp:rdp2009-08
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  1. Baxter, M. & Jermann, U.J., 1993. "The International Diversification Puzzle is Worse than you Think," RCER Working Papers 350, University of Rochester - Center for Economic Research (RCER).
  2. 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.
  3. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial Globalization and Real Regionalization," CEPR Discussion Papers 3268, C.E.P.R. Discussion Papers.
  4. Jean Imbs, 2004. "Trade, Finance, Specialization, and Synchronization," The Review of Economics and Statistics, MIT Press, vol. 86(3), pages 723-734, August.
  5. 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.
  6. 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.
  7. Alan Sutherland & Michael B Devereux, 2007. "Country Portfolio Dynamics," 2007 Meeting Papers 386, Society for Economic Dynamics.
  8. 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.
  9. Cedric Tille & Eric van Wincoop, 2007. "International Capital Flows," Working Papers 122007, Hong Kong Institute for Monetary Research.
  10. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 601-627, April.
  11. 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.
  12. repec:bla:restud:v:75:y:2008:i:4:p:1215-1256 is not listed on IDEAS
  13. Anna Pavlova & Roberto Rigobon, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," Review of Economic Studies, Oxford University Press, vol. 75(4), pages 1215-1256.
  14. Giovanni Lombardo & Luca Dedola, 2010. "Financial Frictions, Financial Integration and the International Propagation of Shocks," 2010 Meeting Papers 288, Society for Economic Dynamics.
  15. Imbs, Jean, 2006. "The real effects of financial integration," Journal of International Economics, Elsevier, vol. 68(2), pages 296-324, March.
  16. Faia, Ester, 2007. "Finance and international business cycles," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1018-1034, May.
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