Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion

Nicolae Gârleanu, Stavros Panageas and Jianfeng Yu

American Economic Review, 2015, vol. 105, issue 7, 1979-2010

Abstract: We propose a unified model of limited market integration, asset-price determination, leveraging, and contagion. Investors and firms are located on a circle, and access to markets involves participation costs that increase with distance. Due to a complementarity between participation and leverage decisions, the equilibrium may exhibit diverse leverage and participation choices across investors, although investors are ex ante identical. Small changes in market-access costs can cause a change in the type of equilibrium, leading to discontinuous price changes, deleveraging, and portfolio-flow reversals. Moreover, the market is subject to contagion—an adverse shock to investors in some locations affects prices everywhere. (JEL D83, G11, G12, G32, G35)

JEL-codes: D83 G11 G12 G32 G35 (search for similar items in EconPapers)
Date: 2015
Note: DOI: 10.1257/aer.20131076
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Citations: View citations in EconPapers (29)

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Working Paper: Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion (2014)
Working Paper: Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion (2013)
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