International Financial Integration*

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Problems in constructing “benchmark” portfolios arise because of the scarcity of data
on the currency composition of external portfolios, as well as on the geographical
allocation of external assets. ²⁶ In general, constructing benchmark yields and rates of
return is easier for external liabilities than it is for external assets. For example, domestic
stock market returns provide a reasonable benchmark for returns on portfolio equity
liabilities. Benchmark yields and returns on debt instruments are more difficult to
construct, in the absence of information on the currency of denomination. Taking into
account these constraints, we have proceeded as follows.

• For portfolio equity liabilities, we use as a benchmark for returns (measured in
US$) the total returns index from the domestic stock market, constructed by
Morgan Stanley Capital International (MSCI).

• For portfolio equity assets, we make use of two alternative indices.

a) The MSCI world stock price index—a valid proxy for capital gains if all
countries allocate their external equity holdings in shares reflecting the world
portfolio. Clearly this index cannot contribute to explaining cross-country
heterogeneity in rates of return on portfolio equity assets, except for countries
with a significant weight in the world index, such as the United States, the
United Kingdom, and Japan.

²⁶ Significant progress in this area has been made in recent years. For example, the 1997
IMF Portfolio Survey provides data on the geographical allocation of portfolio investment
assets for 29 countries. A new, more comprehensive survey is currently being conducted.
Also, countries such as Australia, Sweden, and the United States provide data on the
currency composition of external holdings.

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