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Luca Dedola, ECB Print
Tuesday, 23 February 2010, 14:00 - 15:30

Financial Frictions, Financial Integration and the International Propagation of Shocks

Luca Dedola, European Central Bank

Abstract: This paper develops a two-country model with a financial accelerator and endogenous portfolio choice to study how the international transmission of asymmetric shocks is affected when levered investors hold cross-border risky assets.  Foreign exposure in interconnected balance sheets of levered investors can act as a powerful propagation mechanism across countries. However, in the model financial  and real interdependence can be very strong even with minimal balance sheet exposure to foreign risky assets, if asset markets are integrated across the board, reflecting a strong pressure towards the cross-border equalization of external finance premia faced by levered investors. In turn, the resulting global flight to quality may bring about tight international linkages in (de-)leveraging, financial   and macroeconomic dynamics.

Location: S 12.227
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