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International Transmission of Financial Shocks in an Estimated DSGE model

Uluc Aysun () and Sami Alpanda ()

No 2012-06, Working Papers from University of Central Florida, Department of Economics

Abstract: This paper investigates the transmission mechanism of financial shocks across large economies. To quantify these effects, we construct and estimate a two-region open economy DSGE model with nominal and real rigidities. We model the financial side of the economies using the financial accelerator mechanism of Bernanke et al. (1999). We find that the baseline model fails to generate the high degree of macroeconomic correlation between the U.S. and Euro Area economies. Allowing for an ad hoc, cross-regional correlation in financial shocks considerably improves the model’s ability to replicate the spill-over effects of U.S. financial shocks. We then extend the baseline model by including global banking and generate an endogenous, crossregional correlation of cost of capital. Simulations demonstrate a larger Euro Area response to U.S. shocks and highlight the importance of including frictions in international financial contracts, and not only in domestic financial contracts, for more accurately capturing the international transmission of domestic shocks.

Keywords: DSGE; financial accelerator; international business cycles; global banks (search for similar items in EconPapers)
JEL-codes: E32 E44 F33 F44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-opm
Date: 2012-10
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Journal Article: International transmission of financial shocks in an estimated DSGE model (2014) Downloads
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