Global Collateral: How Financial Innovation Drives Capital Flows and Increases Financial InstabilityAuthor(s):
Publication Date: February 2017
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.
Collateral, Financial innovation, Asset prices, Capital flows, Securitized markets, Asset-backed securities, Global imbalances
JEL Classification Codes: D52, D53, E32, E44, F34, F36, G01, G11, G12