Market Integration and Global Crashes
39 Pages Posted: 25 Jul 2016
Date Written: July 23, 2016
We develop an equilibrium model of real and financial market integration in which real firms and financial investors independently decide on their investment into different locations (countries). We show that, in the presence financial frictions, firms' real investment choices become strategic complements, leading to multiple, self-fulfilling equilibria. This fragility may lead to a global crash in which severe underinvestment into countries with under-developed financial markets spills over to countries connected to them by real investment linkages. We show that such global crashes are particularly severe when frictions are sufficiently symmetric across countries. By contrast, with enough asymmetry, the economy is likely to end up in a local crash equilibrium in which countries with low real investment barriers suffer the most.
Keywords: Market Integration, Foreign Direct Investment, Frictions, Fragility, Crashes, Crises
JEL Classification: G01, G12, F62, F65, F36
Suggested Citation: Suggested Citation