Leverage Constraints and the International Transmission of Shocks

Michael B. Devereux, James Yetman

NBER Working Paper No. 16226
Issued in July 2010
NBER Program(s):   IFM

Recent macroeconomic experience has drawn attention to the importance of interdependence among countries through financial markets and institutions, independently of traditional trade linkages. This paper develops a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained investors. In our model, without leverage constraints on investment, financial integration itself has no implication for international macro co-movements. When leverage constraints bind however, the presence of these constraints in combination with diversified portfolios introduces a powerful financial transmission channel which results in a positive co-movement of production, independently of the size of international trade linkages. In addition, the paper shows that, with binding leverage constraints, the type of financial integration is critical for international co-movement. If international financial markets allow for trade only in non-contingent bonds, but not equities, then the international co-movement of shocks is negative. Thus, with leverage constraints, moving from bond trade to equity trade reverses the sign of the international transmission of shocks.

download in pdf format
   (234 K)

email paper

This paper is available as PDF (234 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w16226

Published: Michael B. Devereux & James Yetman, 2010. "Leverage Constraints and the International Transmission of Shocks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 71-105, 09. citation courtesy of

Users who downloaded this paper also downloaded these:
Giavazzi and Giovannini w16228 Central Banks and the Financial System
Devereux and Sutherland w14372 Country Portfolios in Open Economy Macro Models
Cetorelli and Goldberg w15974 Global Banks and International Shock Transmission: Evidence from the Crisis
Devereux and Sutherland w14794 Valuation Effects and the Dynamics of Net External Assets
Cook and Devereux w17131 Sharing the Burden: Monetary and Fiscal Responses to a World Liquidity Trap
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us