I. Introduction
International financial integration is increasing. Capital account restrictions have been
lifted in many countries, other barriers to investing overseas are also being dismantled, and
the level of activity in international financial markets has increased markedly over the last
decades. This paper studies the dynamics of international financial integration using data
on the level and composition of foreign assets and liabilities for a set of industrial
countries. More specifically, we do the following:
1. Characterize the salient features of the increase in international financial integration
during the past two decades;
2. Relate the growth in foreign asset and liability positions to potential “drivers” of
integration (lifting of policy restrictions, increases in goods trade and output per capita,
domestic financial developments, privatization programs, tax policy);
3. Study the behavior of rates of return on external assets and liabilities and relate them to
differences in portfolio composition.
With regard to the first point, we address several questions. Has the composition of
country portfolios systematically changed over time? To what degree does the increase in
external assets and liabilities reflect valuation effects due to the stock market boom of the
1990s? What are the relative contributions of valuation changes (such as stock market and
currency fluctuations) and new capital flows in determining gross international investment
positions?
With regard to the second point, we ask whether the time series and cross-sectional
patterns in the levels and composition of cross-holdings can be systematically related to
factors such as the increase in world trade in goods and services and rising income levels,
as well as to “policy events” such as capital account liberalization; privatization programs;
domestic financial liberalization; and other regulatory changes.