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on International Finance |
| By: | Michael B. Devereux; Changhua Yu |
| Abstract: | International financial integration helps to diversify risk but also may increase the trans- mission of crises across countries. We provide a quantitative analysis of this trade-off in a two-country general equilibrium model with endogenous portfolio choice and collateral con- straints. Collateral constraints bind occasionally, depending upon the state of the economy and levels of inherited debt. The analysis allows for different degrees of financial integration, moving from financial autarky to bond market integration and equity market integration. Fi- nancial integration leads to a significant increase in global leverage, doubles the probability of balance sheet crises for any one country, and dramatically increases the degree of 'contagion' across countries. Outside of crises, the impact of financial integration on macro aggregates is relatively small. But the impact of a crisis with integrated international financial markets is much less severe than that under financial market autarky. Thus, a trade-off emerges between the probability of crises and the severity of crises. Financial integration can raise or lower welfare, depending on the scale of macroeconomic risk. In particular, in a low risk environment, the increased leverage resulting from financial integration can reduce welfare of investors. |
| JEL: | D52 F36 F44 G11 G15 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20526&r=ifn |
| By: | Binder, Michael; Offermanns, Christian J. |
| Abstract: | We revisit medium- to long-run exchange rate determination, focusing on the role of international investment positions. To do so, we make use of a new econometric framework accounting for conditional long-run homogeneity in heterogeneous dynamic panel data models. In particular, in our model the long-run relationship between effective exchange rates and domestic as well as weighted foreign prices is a homogeneous function of a country's international investment position. We find rather strong support for purchasing power parity in environments of limited negative net foreign asset to GDP positions; furthermore, long-run exchange rate equilibria may have little relation to purchasing power parity outside such environments. We thus argue that the purchasing power parity hypothesis holds conditionally, but not unconditionally, and that international investment positions are an essential component to characterizing this conditionality. |
| Keywords: | exchange rate determination,international financial integration,dynamic panel data models |
| JEL: | F31 F37 C23 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:fubsbe:201423&r=ifn |