Shock spillovers and international financial (dis)integration

Global shocks - ranging from climate-related disasters and geopolitical conáicts to pandemics - transmit rapidly across borders and shape Önancial market co-movements. This paper develops a two-country general equilibrium model to study how cross-border shock spillovers a§ect optimal international portfolio holdings and the degree of Önancial (dis)integration. The analysis highlights that both the magnitude and heterogeneity of spillovers across income sources (capital versus labour income) play a central role in determining international risk-sharing opportunities. When spillovers mainly a§ect capital income, countries reduce their foreign asset positions and markets become more segmented. By contrast, when labour-income spillovers dominate, Önancial integration strengthens. The model generates empirical implications regarding the relation between global shocks, international portfolio rebalancing, and time-varying degrees of Önancial integration, providing a structural framework that can help interpret recent episodes of global Önancial fragmentation.