BUSINESS CYCLES AND THE ASSET STRUCTURE OF FOREIGN-TRADE

International financial markets are widely believed to be important fo r the international transmission of business cycles, since they determ ine the extent to which individuals can smooth consumption in the pres ence of country-specific shocks to income. Using a two-country equilib rium model with restricted asset trade, we find that the absence of co mplete financial integration may not be important if shocks to nationa l economies have low persistence or are transmitted rapidly across cou ntries. However, if shocks are highly persistent or are not transmitte d internationally, the extent of financial integration is central to t he international transmission of business cycles.