International Financial Integration*

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of activity. In contrast, growth that is linked to positively-trending variables such as output
per capita and goods trade can be predicted to continue into the future.

In our previous work, we have explored the determinants of net foreign asset positions
along the time series dimension (Lane and Milesi-Ferretti 2002a). However, we have
largely examined other components (e.g. debt-equity ratios for foreign liabilities) in a
purely cross-sectional manner (Lane and Milesi-Ferretti 2001a, 2001b). Lane (2000)
provides some evidence on the change in gross cross-holding positions over time for the
OECD countries but does not try to explain the panel dynamics. The available time series
data have increased substantially in recent years, with countries now reporting data on
their external portfolios in much greater detail.

In terms of empirical work on international financial integration, some other authors have
looked at related questions. Bekaert and Harvey (2000) have attempted to date the
integration of emerging market stock exchanges into the global market, using an asset
price model. Henry (2000), Levine et al. (2000), Edison et al (2002), Edison and Warnock
(2002) and O’Donnell (2002), amongst others, have looked at the impact of international
financial integration on various indicators. Obstfeld and Taylor (2002) provide a wide-
ranging historical overview, including analysis of the long-run changes in gross asset
trade. For Europe, Adam et al (2002) explore a wide range of measures of international
financial integration. Finally, we note that such a study of the “growth in world asset
trade” is complementary to the recent literature on the growth in world trade (Hummels et
al 2001, Yi 2003).

The empirical literature on the rates of return earned on foreign assets and liabilities is
very small. Bond (1977), Sorensen and Yosha (1998) and Lane (2001) study the behavior
of investment income flows but not the contribution of capital gains and losses, while
Sorensen, Yosha and Wu (2002) also provide some indirect evidence on the role of

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