Global Collateral: How Financial Innovation Drives Capital Flows and Increases Financial Instability

55 Pages Posted: 22 Feb 2017  

Ana Fostel

University of Virginia

John Geanakoplos

Yale University - Cowles Foundation

Gregory Phelan

Williams College

Date Written: February 4, 2017

Abstract

We show that cross-border financial flows arise when countries differ in their abilities to use assets as collateral. Financial integration is a way of sharing scarce collateral. The ability of one country to leverage and tranche assets provides attractive financial contracts to investors in the other country, and general equilibrium effects on prices create opportunities for investors in the financially advanced country to invest abroad. Foreign demand for collateral and for collateral-backed financial promises increases the collateral value of domestic assets, and cheap foreign assets provide attractive returns to investors who do not demand collateral to issue promises. Gross global flows respond dynamically to fundamentals, exporting and amplifying financial volatility.

Keywords: Collateral, financial innovation, asset prices, capital flows, securitized markets, asset-backed securities, global imbalances

JEL Classification: D52, D53, E32, E44, F34, F36, G01, G11, G12

Suggested Citation

Fostel, Ana and Geanakoplos, John and Phelan, Gregory, Global Collateral: How Financial Innovation Drives Capital Flows and Increases Financial Instability (February 4, 2017). Cowles Foundation Discussion Paper No. 2076. Available at SSRN: https://ssrn.com/abstract=2921456 or http://dx.doi.org/10.2139/ssrn.2921456

Ana Fostel

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

John D Geanakoplos (Contact Author)

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States
203-432-3397 (Phone)
203-432-6167 (Fax)

HOME PAGE: http://cowles.econ.yale.edu/P/au/d_gean.htm

Gregory Phelan

Williams College ( email )

Williamstown, MA 01267
United States

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