Discussion Paper Details

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Title: Financial Integration and Asset Returns

Author(s): Philippe Martin and Hélène Rey

Publication Date: November 1999

Keyword(s): Asset Trade, Cross-Listing, Financial Integration and Transaction Costs

Programme Area(s): Financial Economics, International Macroeconomics and International Trade and Regional Economics

Abstract: The paper investigates the impact of financial integration on asset return, risk diversification and breadth of financial markets. We analyse a three-country macroeconomic model in which i) the number of financial assets is endogenous; ii) assets are imperfect substitutes; iii) cross-border asset trade entails some transaction costs; iv) the investment technology is indivisible. In such an environment, lower transaction costs between two financial markets translate into higher demand for assets issued on those markets, higher asset price and larger diversification. For the country left outside the integrated area, the welfare impact is ambiguous: it enjoys better risk diversification but faces an adverse movement in its financial terms of trade. When we endogenise financial market location, we find that financial integration benefits the largest economy of the integrated area. Only when transaction costs become very small does financial integration lead to relocation of markets in the smallest economy.

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Bibliographic Reference

Martin, P and Rey, H. 1999. 'Financial Integration and Asset Returns'. London, Centre for Economic Policy Research.