Financial Crisis Contagion - Introducing the Finance Co-Movement Slope

How do capital flows affect the synchronization of two countries’ financial cycles? We obtain data onbilateral capital flows and domestic financial cycles to introduce a ”Finance Co-movement Slope” thatdescribes this relationship. We find that this slope is positive and increasing in the time horizon over whichit is calculated, but financial synchronization is reduced the more asymmetric the capital flows are. Thesignificance of these effects implies that financing is only imperfectly substitutable across countries. Weshow that an existing DSGE model of cross-border capital flows can replicate the main empirical findings.We then use the model to gain further insights on the channels that drive the shape of the Finance Co-movementSlope and conduct policy experiments designed to dampen financial synchronization