Heterogeneous Impact of the Global Financial Cycle

I develop a heterogeneous-country model of the world economy to study the distributional impact of aggregate capital flight episodes. A global intermediary borrows from all countries and invests in their risky assets. Wealth heterogeneity between countries arises endogenously due to idiosyncratic shocks. A single global factor that combines the intermediary's wealth and risk-taking capacity determines capital inflows and risk premia in every country. A shock to the intermediary's risk-taking capacity generates global capital flight. Investors from rich countries use their external savings to replace foreign demand for domestic assets. These countries experience a ``retrenchment'' event: a sizable fall in outward flows. Their risky assets appreciate on impact. In poor countries, investors cannot replace foreign demand without a sharp rise in risk premia. Their asset markets adjust through prices rather than quantities, and prices fall. Estimating the model, I find that global financial shocks explain a quarter of the time-series variation in aggregate capital flows and a third of the variation in the relative performance of assets in advanced economies compared to emerging markets.