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Cheap But Flighty: How Global Imbalances Create Financial Fragility

Toni Ahnert () and Enrico Perotti ()

Staff Working Papers from Bank of Canada

Abstract: We analyze how a wealth shift to emerging countries may lead to instability in developed countries. Investors exposed to expropriation risk are willing to pay a safety premium to invest in countries with good property rights. Domestic intermediaries compete for such cheap funding by carving out safe claims, which requires demandable debt. While foreign inflows allow countries to expand their domestic credit, risk-intolerant foreign investors withdraw even under minimal uncertainty. We show that more foreign funding causes larger and more frequent runs. Beyond some scale, even risk-tolerant domestic investors are induced to withdraw to avoid dilution. As excess liquidation causes social losses, a domestic planner may seek prudential measures on the scale of foreign inflows.

Keywords: Financial stability; Financial institutions (search for similar items in EconPapers)
JEL-codes: F3 G2 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2015
New Economics Papers: this item is included in nep-ifn
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Related works:
Working Paper: Cheap but flighty: how global imbalances create financial fragility (2015) Downloads
Working Paper: Cheap but Flighty: How Global Imbalances create Financial Fragility (2015) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:15-33

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