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Title: Market Integration and Global Crashes

Author(s): Semyon Malamud and Aytek Malkhozov

Publication Date: August 2016

Keyword(s): Crashes, Crises, Financial Frictions and market integration

Programme Area(s): Financial Economics and International Macroeconomics and Finance

Abstract: We develop an equilibrium model of real and financial market integration in which real firms and financial actors independently decide on their investment into different locations (countries). We show that, in the presence of financial frictions, firms' real investment choices may become strategic complements, leading to multiple, self-fulfilling equilibria, as well as to real fragility, whereby a small change in one country's fundamentals triggers a large large change in real investment everywhere. This fragility may lead to a global crash in which severe underinvestment into countries with under-developed financial markets spills over all other countries. 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.

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Bibliographic Reference

Malamud, S and Malkhozov, A. 2016. 'Market Integration and Global Crashes'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11468