International Financial Integration*

-10-
assets are imperfect substitutes, and cross-border asset trade entails transactions costs.
Under these assumptions, a reduction in international transactions costs stimulates an
increase in the demand for (and supply of) assets and an increase in asset prices, leading to
higher cross-border diversification.

As such, our empirical strategy is to identify a set of country characteristics that may
influence the benefits to and costs of international asset trade. Most obviously, we
consider the impact of controls on cross-border capital movements. If controls are binding,
the level of international asset cross-holdings should increase if the capital account is
liberalized.

Second, we investigate the connection between trade in goods and services and trade in
assets. Goods trade may matter for several reasons. First, much goods trade directly entails
corresponding financial transactions (e.g. trade credit and export insurance). Second,
following Obstfeld and Rogoff (2000), there is a close connection between the gains to
international financial diversification and the extent of goods trade: trade costs create an
international wedge between marginal rates of substitution and hence limit the gains to
asset trade. Third, goods trade and financial positions are jointly determined in some
situations, as is often the case with FDI, given the importance of intra-firm intermediates
trade. Finally, openness in goods markets may increase the willingness to conduct cross-
border financial transactions, reducing financial home bias (a ‘familiarity’ effect).⁶
Income per capita may also influence the propensity to engage in international asset trade.
To the extent that higher income per capita is associated with lower risk aversion and
international investments are perceived as riskier than domestic alternatives, it may also
raise international asset trade. If participation in foreign asset markets involves fixed costs

⁶For Ireland, Honohan and Lane (2000) show that the bilateral pattern of goods trade
explains the bilateral pattern of portfolio equity investment very well.

<<   10   11   12   13   14   15   16   >>

More intriguing information