International Financial Integration*

-26-
is an estimated rate of return on some observable market portfolio.²⁸

As was outlined in the previous subsection, we consider two market portfolios in tracking
the returns on foreign portfolio equity assets: (a) the MSCI world stock return index; and
(b) an index based on the portfolio weights reported in the 1997 IMF Portfolio Survey.²⁹
We use the national domestic stock market return index in tracking the rate of return on
foreign portfolio equity liabilities.

To explain the rate of return on FDI assets and liabilities, we again use the MSCI return
indices. For FDI assets, we also use partner countries’ stock market returns weighted using
relative shares in overseas FDI positions, as reported in the OECD International Direct
Investment Statistical Yearbook. We report results separately for countries reporting FDI
at book and at market value, and we expect stock market return indices to do a better job
in the latter case.

We aggregate data from the portfolio bond and other debt categories into a single
aggregate rate of return on debt. As explained in the previous subsection, for foreign debt
assets we consider a weighted index of bond returns, based on bond holdings as reported
in the 1997 IMF Portfolio Survey, with bond returns on ten-year government bonds taken
from Global Financial Data.

We also consider the yields on the debt component. For the yield on debt assets, we
consider two sets of portfolio weights: (i) bond weights from the IMF portfolio survey;

²⁸ The equation allows for a non-unitary coefficient on the market return index, since the
market return and the omitted idiosyncratic element may be correlated.

²⁹ For US and UK, we use the MSCI indices that exclude these countries respectively.
With respect to the IMF Portfolio Survey, we calculate portfolios on the basis of
investment positions in six major markets: the US, the UK, Japan, France, Germany and
Italy. These portfolio shares only refer to end-1997: we make the heroic and obviously
imperfect assumption that these weights are good indicators for the other years in our
sample.

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