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Cheap But Flighty: How Global Imbalances Create Financial Fragility

By Toni Ahnert and Enrico Perotti

Abstract

We analyze how a wealth shift to emerging countries may lead to instability in developed countries. Investors exposed to expropriation risk are willing to pay a safety premium to invest in countries with good property rights. Domestic intermediaries compete for such cheap funding by carving out safe claims, which requires demandable debt. While foreign inflows allow countries to expand their domestic credit, risk-intolerant foreign investors withdraw even under minimal uncertainty. We show that more foreign funding causes larger and more frequent runs. Beyond some scale, even risk-tolerant domestic investors are induced to withdraw to avoid dilution. As excess liquidation causes social losses, a domestic planner may seek prudential measures on the scale of foreign inflows

Topics: F3, G2, ddc:330, Financial stability, Financial institutions
Publisher: Ottawa: Bank of Canada
Year: 2015
OAI identifier: oai:econstor.eu:10419/123778
Provided by: EconStor

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