IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/19381.html
   My bibliography  Save this paper

Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion

Author

Listed:
  • Nicolae Gârleanu
  • Stavros Panageas
  • Jianfeng Yu

Abstract

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.

Suggested Citation

  • Nicolae Gârleanu & Stavros Panageas & Jianfeng Yu, 2013. "Financial Entanglement: A Theory of Incomplete Integration, Leverage, Crashes, and Contagion," NBER Working Papers 19381, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:19381
    Note: AP EFG IFM
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w19381.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Allen, Franklin & Babus, Ana & Carletti, Elena, 2012. "Asset commonality, debt maturity and systemic risk," Journal of Financial Economics, Elsevier, vol. 104(3), pages 519-534.
    2. Hoggarth, Glenn & Mahadeva, Lavan & Martin, Jeremy, 2010. "Financial Stability Paper No 8: Understanding International Bank Capital Flows during the Recent Financial Crisis," Bank of England Financial Stability Papers 8, Bank of England.
    3. Aviat, Antonin & Coeurdacier, Nicolas, 2007. "The geography of trade in goods and asset holdings," Journal of International Economics, Elsevier, vol. 71(1), pages 22-51, March.
    4. Anna Pavlova & Roberto Rigobon, 2008. "The Role of Portfolio Constraints in the International Propagation of Shocks," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(4), pages 1215-1256.
    5. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    6. Merton, Robert C, 1987. "A Simple Model of Capital Market Equilibrium with Incomplete Information," Journal of Finance, American Finance Association, vol. 42(3), pages 483-510, July.
    7. Owen A. Lamont, 2012. "Go Down Fighting: Short Sellers vs. Firms," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 2(1), pages 1-30.
    8. repec:hal:spmain:info:hdl:2441/c8dmi8nm4pdjkuc9g708pipbp is not listed on IDEAS
    9. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
    10. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2015. "Systemic Risk and Stability in Financial Networks," American Economic Review, American Economic Association, vol. 105(2), pages 564-608, February.
    11. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    12. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-638, August.
    13. Barlevy, Gadi & Veronesi, Pietro, 2003. "Rational panics and stock market crashes," Journal of Economic Theory, Elsevier, vol. 110(2), pages 234-263, June.
    14. repec:hal:wpspec:info:hdl:2441/c8dmi8nm4pdjkuc9g708pipbp is not listed on IDEAS
    15. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
    16. John H. Cochrane & Francis A. Longstaff & Pedro Santa-Clara, 2008. "Two Trees," The Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 347-385, January.
    17. Vila, Jean-Luc, 1989. "Simple games of market manipulation," Economics Letters, Elsevier, vol. 29(1), pages 21-26.
    18. Joshua D. Coval & Tobias J. Moskowitz, 1999. "Home Bias at Home: Local Equity Preference in Domestic Portfolios," Journal of Finance, American Finance Association, vol. 54(6), pages 2045-2073, December.
    19. Joshua D. Coval & Tobias J. Moskowitz, 2001. "The Geography of Investment: Informed Trading and Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 109(4), pages 811-841, August.
    20. Mark Grinblatt & Matti Keloharju, 2001. "How Distance, Language, and Culture Influence Stockholdings and Trades," Journal of Finance, American Finance Association, vol. 56(3), pages 1053-1073, June.
    21. Bekaert, Geert & Harvey, Campbell R, 1995. "Time-Varying World Market Integration," Journal of Finance, American Finance Association, vol. 50(2), pages 403-444, June.
    22. Giannetti, Mariassunta & Laeven, Luc, 2012. "The flight home effect: Evidence from the syndicated loan market during financial crises," Journal of Financial Economics, Elsevier, vol. 104(1), pages 23-43.
    23. Romer, David, 1993. "Rational Asset-Price Movements without News," American Economic Review, American Economic Association, vol. 83(5), pages 1112-1130, December.
    24. Claudia M. Buch, 2005. "Distance and International Banking," Review of International Economics, Wiley Blackwell, vol. 13(4), pages 787-804, September.
    25. Stijn Van Nieuwerburgh & Laura Veldkamp, 2010. "Information Acquisition and Under-Diversification," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 77(2), pages 779-805.
    26. Head, Keith & Ries, John, 2008. "FDI as an outcome of the market for corporate control: Theory and evidence," Journal of International Economics, Elsevier, vol. 74(1), pages 2-20, January.
    27. Kathy Yuan, 2005. "Asymmetric Price Movements and Borrowing Constraints: A Rational Expectations Equilibrium Model of Crises, Contagion, and Confusion," Journal of Finance, American Finance Association, vol. 60(1), pages 379-411, February.
    28. Huberman, Gur, 2001. "Familiarity Breeds Investment," The Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 659-680.
    29. Adam Zawadowski, 2013. "Entangled Financial Systems," The Review of Financial Studies, Society for Financial Studies, vol. 26(5), pages 1291-1323.
    30. Kalok Chan & Vicentiu Covrig & Lilian Ng, 2005. "What Determines the Domestic Bias and Foreign Bias? Evidence from Mutual Fund Equity Allocations Worldwide," Journal of Finance, American Finance Association, vol. 60(3), pages 1495-1534, June.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Nicolas Coeurdacier & Hélène Rey, 2013. "Home Bias in Open Economy Financial Macroeconomics," Journal of Economic Literature, American Economic Association, vol. 51(1), pages 63-115, March.
    2. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g70969520 is not listed on IDEAS
    3. repec:hal:spmain:info:hdl:2441/c8dmi8nm4pdjkuc9g70969520 is not listed on IDEAS
    4. Eduard Gaar & David Scherer & Dirk Schiereck, 2022. "The home bias and the local bias: A survey," Management Review Quarterly, Springer, vol. 72(1), pages 21-57, February.
    5. Coeurdacier, Nicolas & Guibaud, Stéphane, 2011. "International portfolio diversification is better than you think," Journal of International Money and Finance, Elsevier, vol. 30(2), pages 289-308, March.
    6. repec:spo:wpmain:info:hdl:2441/c8dmi8nm4pdjkuc9g70969520 is not listed on IDEAS
    7. Nicolas Coeurdacier & Hélène Rey, 2010. "Home bias in open economy financial macroeconomics," SciencePo Working papers hal-01069440, HAL.
    8. repec:hal:wpspec:info:hdl:2441/c8dmi8nm4pdjkuc9g70969520 is not listed on IDEAS
    9. repec:hal:wpspec:info:hdl:2441/c8dmi8nm4pdjkuc9g81p7j6b6 is not listed on IDEAS
    10. Fang Cai & Francis E. Warnock, 2004. "International diversification at home and abroad," International Finance Discussion Papers 793, Board of Governors of the Federal Reserve System (U.S.).
    11. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g81p7j6b6 is not listed on IDEAS
    12. Anil Mishra, 2011. "Australia’s equity home bias and real exchange rate volatility," Review of Quantitative Finance and Accounting, Springer, vol. 37(2), pages 223-244, August.
    13. Guiso, Luigi & Sodini, Paolo, 2013. "Household Finance: An Emerging Field," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1397-1532, Elsevier.
    14. Phelim Boyle & Lorenzo Garlappi & Raman Uppal & Tan Wang, 2012. "Keynes Meets Markowitz: The Trade-Off Between Familiarity and Diversification," Management Science, INFORMS, vol. 58(2), pages 253-272, February.
    15. David C. Ling & Chongyu Wang & Tingyu Zhou, 2021. "The Geography of Real Property Information and Investment: Firm Location, Asset Location and Institutional Ownership," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 49(1), pages 287-331, March.
    16. Roque, Vanda & Cortez, Maria Céu, 2014. "The determinants of international equity investment: Do they differ between institutional and noninstitutional investors?," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 469-482.
    17. repec:spo:wpmain:info:hdl:2441/c8dmi8nm4pdjkuc9g81p7j6b6 is not listed on IDEAS
    18. Chan, Kalok & Covrig, Vicentiu, 2012. "What determines mutual fund trading in foreign stocks?," Journal of International Money and Finance, Elsevier, vol. 31(4), pages 793-817.
    19. Fedenia, Mark & Shafer, Sherrill & Skiba, Hilla, 2013. "Information immobility, industry concentration, and institutional investors’ performance," Journal of Banking & Finance, Elsevier, vol. 37(6), pages 2140-2159.
    20. repec:hal:spmain:info:hdl:2441/c8dmi8nm4pdjkuc9g81p7j6b6 is not listed on IDEAS
    21. Mishra, Anil V. & Ratti, Ronald A., 2013. "Home bias and cross border taxation," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 169-193.
    22. Mark Fedenia & Sherrill Shaffer & Hilla Skiba, 2012. "Information immobility, industry concentration, and institutional investors' performance," CAMA Working Papers 2012-24, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    23. Mishra, Anil V., 2014. "Australia's home bias and cross border taxation," Global Finance Journal, Elsevier, vol. 25(2), pages 108-123.
    24. Giannetti, Mariassunta & Laeven, Luc, 2012. "Local Bias and Stock Market Conditions," CEPR Discussion Papers 8969, C.E.P.R. Discussion Papers.
    25. Claude Dupuy & Stephanie Lavigne & Dalila Chenaf-Nicet, 2016. "Where Do “Impatient” Mutual Funds Invest? A Special Attraction for Large Proximate Markets and Companies with Strategic Investors," Post-Print hal-03897273, HAL.
    26. Hans Degryse & Steven Ongena, 2005. "Distance, Lending Relationships, and Competition," Journal of Finance, American Finance Association, vol. 60(1), pages 231-266, February.
    27. Mishra, Anil V., 2015. "Measures of equity home bias puzzle," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 293-312.
    28. Green, T. Clifton & Jame, Russell, 2013. "Company name fluency, investor recognition, and firm value," Journal of Financial Economics, Elsevier, vol. 109(3), pages 813-834.

    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:19381. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.