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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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File URL: https://www.economicdynamics.org/meetpapers/2010/paper_1341.pdf
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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
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Handle: RePEc:red:sed010:1341
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  1. Heathcote, Jonathan & Perri, Fabrizio, 2004. "Financial globalization and real regionalization," Journal of Economic Theory, Elsevier, vol. 119(1), pages 207-243, November.
  2. Cedric Tille & Eric van Wincoop, 2007. "International Capital Flows," Working Papers 122007, Hong Kong Institute for Monetary Research.
  3. Jean Imbs, 2003. "Trade, Finance, Specialization, and Synchronization," IMF Working Papers 03/81, International Monetary Fund.
  4. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University.
  5. 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.
  6. Alan Sutherland & Michael B. Devereux, 2007. "Country Portfolio Dynamics," IMF Working Papers 07/283, International Monetary Fund.
  7. Giovanni Lombardo & Luca Dedola, 2010. "Financial Frictions, Financial Integration and the International Propagation of Shocks," 2010 Meeting Papers 288, Society for Economic Dynamics.
  8. 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.
  9. 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).
  10. Faia, Ester, 2007. "Finance and international business cycles," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1018-1034, May.
  11. Michael B. Devereux & Alan Sutherland, 2008. "Country Portfolios in Open Economy Macro Models," NBER Working Papers 14372, National Bureau of Economic Research, Inc.
  12. 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.
  13. Matteo Iacoviello, 2005. "House Prices, Borrowing Constraints, and Monetary Policy in the Business Cycle," American Economic Review, American Economic Association, vol. 95(3), pages 739-764, June.
  14. 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.
  15. Imbs, Jean, 2004. "The Real Effects of Financial Integration," CEPR Discussion Papers 4335, 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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