Market Integration and Global Crashes

Semyon Malamud and Aytek Malkhozov
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Semyon Malamud: Ecole Polytechnique Federale de Lausanne, Swiss Finance Institute, and Centre for Economic Policy Research (CEPR)
Aytek Malkhozov: Board of Governors of the Federal Reserve System

No 16-49, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We develop an equilibrium model of real and financial market integration in which real firms and financial investors independently decide on their investment into different locations (countries). We show that, in the presence financial frictions, firms' real investment choices become strategic complements, leading to multiple, self-fulfilling equilibria. This fragility may lead to a global crash in which severe underinvestment into countries with under-developed financial markets spills over to countries connected to them by real investment linkages. We show that such global crashes are particularly severe when frictions are sufficiently symmetric across countries. By contrast, with enough asymmetry, the economy is likely to end up in a local crash equilibrium in which countries with low real investment barriers suffer the most.

Keywords: Market Integration; Foreign Direct Investment; Frictions; Fragility; Crashes; Crises (search for similar items in EconPapers)
JEL-codes: F36 F62 F65 G01 G12 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2016-07
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1649

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