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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
2282.
Find related papers by JEL classification: F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance G1 - Financial Economics - - General Financial Markets G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Svensson, Lars E O, 1988.
"Trade in Risky Assets,"
American Economic Review,
American Economic Association, vol. 78(3), pages 375-94, June.
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