Working Paper: NBER ID: w17686
Authors: Eric Van Wincoop
Abstract: The 2008-2009 financial crises, while originating in the United States, witnessed a drop in asset prices and output that was at least as large in the rest of the world as in the United States. A widely held view is that this was the result of global transmission through leveraged financial institutions. We investigate this in the context of a simple two-country model. The paper highlights what the various transmission mechanisms associated with balance sheet losses are, how they operate, what their magnitudes are and what the role is of different types of borrowing constraints faced by leveraged institutions. For realistic parameters we find that the model cannot account for the global nature of the crisis, both in terms of the size of the impact and the extent of transmission.
Keywords: International contagion; Leveraged financial institutions; Financial crisis
JEL Codes: E32; F3; F4; G12; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial shock in home country (F65) | Decreased asset prices in foreign country (G15) |
| Financial shock in home country (F65) | Decreased lending rates in foreign country (F34) |
| Home asset defaults (G51) | Decreased asset prices in foreign country (G15) |
| Home asset price drops (R31) | Balance sheet valuation effects in foreign country (F31) |
| Changes in portfolio allocations (G11) | Reduced demand for foreign assets (F31) |
| Leverage and borrowing constraints (G51) | Transmission of shocks (F42) |
| Home country’s financial distress (F65) | Decreased asset prices in foreign country (G15) |
| Home country’s financial distress (F65) | Decreased lending rates in foreign country (F34) |