Publication Date: February 2019
Cross-border ﬁnancial flows arise when (otherwise identical) countries diﬀer in their abilities to use assets as collateral to back ﬁnancial contracts. Financially integrated countries have access to the same set of ﬁnancial instruments, and yet there is no price convergence of assets with identical payoﬀs, due to a gap in collateral values. Home (ﬁnancially advanced) runs a current account deﬁcit. Financial flows amplify asset price volatility in both countries, and gross flows driven by collateral diﬀerences collapse following bad news about fundamentals. Our results can explain ﬁnancial flows among rich, similarly-developed countries, and why these flows increase volatility.
Keywords: Collateral, Capital flows, Asset prices, Current account, Securitized markets, Asset-backed securities
JEL Classification Codes: D52, D53, E32, E44, F34, F36, G01, G11, G12