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Global Collateral: How Financial Innovation Drives Capital Flows and Increases Financial Instability

Ana Fostel, John Geanakoplos and Gregory Phelan ()
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John Geanakoplos: Yale University, http://economics.yale.edu/

No 2015-12, Department of Economics Working Papers from Department of Economics, Williams College

Abstract: We show that cross-border financial flows arise when levels of financial innovation differ across countries. Financial integration is a way of sharing scarce collateral. The ability of one country to leverage and tranche assets provides attractive financial contracts to investors in the other country, and general equilibrium effects on prices create opportunities for investors in the sophisticated country to invest abroad. Foreign demand for collateral and for collateral-backed financial promises increases the collateral value of domestic assets, and cheap foreign assets provide attractive returns to investors who do not demand collateral to issue promises. Gross global flows respond dynamically to fundamentals, exporting and amplifying financial volatility.

Keywords: Collateral; financial innovation; asset prices; capital flows; securitized markets; asset-backed securities; global imbalances (search for similar items in EconPapers)
JEL-codes: D52 D53 E32 E44 F34 F36 G01 G11 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-fmk, nep-ifn and nep-ino
Date: 2015-07, Revised 2017-02
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