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Leverage Constraints and the International Transmission of Shocks

Michael Devereux () and James Yetman ()

No 132010, Working Papers from Hong Kong Institute for Monetary Research

Abstract: Recent macroeconomic experience has drawn attention to the importance of interdependence among countries through financial markets and institutions, independently of traditional trade linkages. This paper develops a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained investors. In our model, without leverage constraints on investment, financial integration itself has no implication for international macro co-movements. When leverage constraints bind however, the presence of these constraints in combination with diversified portfolios introduces a powerful financial transmission channel which results in a positive co-movement of production, independently of the size of international trade linkages. In addition, the paper shows that, with binding leverage constraints, the type of financial integration is critical for international co-movement. If international financial markets allow for trade only in non-contingent bonds, but not equities, then the international co-movement of shocks is negative. Thus, with leverage constraints, moving from bond trade to equity trade reverses the sign of the international transmission of shocks.

Keywords: Leverage; International Transmission; Portfolios (search for similar items in EconPapers)
JEL-codes: F3 F32 F34 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2010-05
New Economics Papers: this item is included in nep-bec, nep-dge, nep-ifn and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (190) Track citations by RSS feed

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Related works:
Journal Article: Leverage Constraints and the International Transmission of Shocks (2010)
Journal Article: Leverage Constraints and the International Transmission of Shocks (2010) Downloads
Working Paper: Leverage constraints and the international transmission of shocks (2010) Downloads
Working Paper: Leverage Constraints and the International Transmission of Shocks (2010) Downloads
Working Paper: leverage constraints and the international transmission of shocks (2010) Downloads
Working Paper: Leverage Constraints and the International Transmission of Shocks (2009) Downloads
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