Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion / Nicolae Gârleanu, Stavros Panageas, Jianfeng Yu.

Format:

Book

Author/Creator:

Gârleanu, Nicolae.

Contributor:

National Bureau of Economic Research.

Panageas, Stavros.

Yu, Jianfeng.

Series:

Working Paper Series (National Bureau of Economic Research) no. w19381.

NBER working paper series no. w19381

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Financial Entanglement

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2013.

Summary:

We propose a unified model of limited market integration, asset-price determination, leveraging, and contagion. Investors and firms are located on a circle, and access to markets involves participation costs that increase with distance. Despite the ex-ante symmetry of investors, their strategies may (endogenously) exhibit diversity, with some investors in each location following high-leverage, high-participation, and high-cost strategies and some unleveraged, low-participation, and low-cost strategies. The capital allocated to high-leverage strategies may be vulnerable even to small changes in market-access costs, which can lead to discontinuous price drops, de-leveraging, and portfolio-flow reversals. Moreover, the market is subject to contagion, in that an adverse shock to investors at a subset of locations affects prices everywhere.

Notes:

Print version record

August 2013.