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leverage constraints and the international transmission of shocks

  • James Yetman

    (Bank for International Settlements)

  • Michael B. Devereux

    (University of British Columbia)

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

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Date of creation: 2010
Date of revision:
Handle: RePEc:red:sed010:1341
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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