Market Integration and Global Crashes

Semyon Malamud and Aytek Malkhozov

No 11468, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We develop an equilibrium model of real and financial market integration in which real firms and financial actors independently decide on their investment into different locations (countries). We show that, in the presence of financial frictions, firms' real investment choices may become strategic complements, leading to multiple, self-fulfilling equilibria, as well as to real fragility, whereby a small change in one country's fundamentals triggers a large large change in real investment everywhere. This fragility may lead to a global crash in which severe underinvestment into countries with under-developed financial markets spills over all other countries. 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; Crises; Crashes; Financial frictions (search for similar items in EconPapers)
JEL-codes: F36 F62 F65 G01 G12 (search for similar items in EconPapers)
Date: 2016-08
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Citations: View citations in EconPapers (1)

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