Evaluating international financial integration under leverage constraints

Michael B. Devereux, Alan Sutherland

    Research output: Contribution to journalArticlepeer-review

    25 Citations (Scopus)

    Abstract

    The global financial crisis has undermined many economists' views about the benefits of open financial markets. Anecdotal evidence seems to indicate that financial linkages may propagate shocks during crises. This paper develops a simple two-country model in which financial liberalisation across countries takes place in the presence of credit market distortions within countries. Countries may be subject to macro risk coming from productivity shocks and direct shocks to the credit system ('financial shocks'). Three different degrees of financial linkages between countries are examined. It is shown that the type of financial integration is critical for both macroeconomic outcomes and welfare. In particular, financial integration in bond markets alone may increase aggregate consumption volatility and reduce welfare. Financial integration in both bond and equity markets generates high positive co-movement across countries, but is welfare-improving. (C) 2010 Elsevier B.V. All rights reserved.

    Original languageEnglish
    Pages (from-to)427-442
    Number of pages16
    JournalEuropean Economic Review
    Volume55
    Issue number3
    DOIs
    Publication statusPublished - Apr 2011

    Keywords

    • International financial integration
    • Leverage constraints
    • Welfare
    • BUSINESS CYCLES
    • MARKETS
    • TRADE

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