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The literature on leverage until now shows how an increase in volatility reduces leverage. However, in order to explain pro-cyclical leverage it assumes that bad news increases volatility. This paper suggests a reason why bad news is more often than not associated with higher future volatility. We show that, in a model with endogenous leverage and heterogeneous beliefs, agents have the incentive to invest mostly in technologies that become volatile in bad times. Together with the old literature this explains pro-cyclical leverage. The result also gives rationale to the pattern of volatility smiles observed in the stock options since 1987. Finally, the paper presents for the first time a dynamic model in which an asset is endogenously traded simultaneously at different margin requirements in equilibrium.

Stock price forecasting. --- Speculation --- Information technology --- Bucket-shops --- Commercial corners --- Corners, Commercial --- Finance --- Gambling --- Commodity exchanges --- Contracts, Aleatory --- Investments --- Stock exchanges --- Forecasting, Stock price --- Security price forecasting --- Stocks --- Business forecasting --- Prices --- Forecasting --- Investments: General --- Investments: Bonds --- Macroeconomics --- Industries: Financial Services --- Incomplete Markets --- General Equilibrium and Disequilibrium: Financial Markets --- Financial Markets and the Macroeconomy --- Financial Crises --- Portfolio Choice --- Investment Decisions --- General Financial Markets: General (includes Measurement and Data) --- Price Level --- Inflation --- Deflation --- Banks --- Depository Institutions --- Micro Finance Institutions --- Mortgages --- Macroeconomics: Consumption --- Saving --- Wealth --- Investment & securities --- Asset prices --- Collateral --- Bonds --- Securities --- Consumption --- Loans --- Financial instruments --- Economics

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This paper examines Latin America's access to international capital markets from 1980 to 2005, with particular attention to the role of domestic and external factors. To capture access to international markets, we use primary gross issuance in international bond, equity, and syndicated-loan markets. Using panel estimation, we find that sound fundamentals matter. For example, Argentina, Brazil, and Chile's superb performance in capital markets during the early 1990s has been in large part driven by better fundamentals. However, the upsurge in international lending to Latin America starting in 2003 has been mainly driven by a dramatic increase in global liquidity.

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Cross-border financial flows arise when (otherwise identical) countries differ in their abilities to use assets as collateral to back financial contracts. Financially integrated countries have access to the same set of financial instruments, and yet there is no price convergence of assets with identical payoffs, due to a gap in collateral values. Home (financially advanced) runs a current account deficit. Financial flows amplify asset price volatility in both countries, and gross flows driven by collateral differences collapse following bad news about fundamentals. Our results can explain financial flows among rich, similarly-developed countries, and why these flows increase volatility.