Securitized Markets, International Capital Flows, and Global Welfare

Abstract

We study the effect of collateralized lending and securitization on the global supply of securitized assets, welfare, and international net and gross capital flows in a two country general equilibrium model with idiosyncratic investment risk. The financial sectors in the two countries, Home and Foreign, differ by the collateral requirement for investment loans, with Home requiring lower margins. In autarky, Home endogenously supplies more assets and enables more risk sharing. Upon financial integration, capital flows from Foreign to Home, leading to lower interest rates and an increase in the global supply of assets. Foreign enjoys substantial welfare gains through better risk sharing and portfolio reallocation, while the welfare experience for Home is ambiguous. Gross capital flows arise when agents face aggregate shocks to the expected payoff to investment projects, but can collapse when shocks concern the variance of returns.