This paper examines the effect of volatility on the costs and benefits of financial market integration. The basic framework combines the costly state verification model and the contract enforceability approach. The welfare effects of financial market integration are assessed by comparing welfare under financial autarky and financial openness -- under which foreign banks, characterized by lower costs of intermediation and a lower markup rate, have free access to domestic capital markets. The analysis shows that financial integration may be welfare reducing if world interest rates under openness are highly volatile. The basic framework is then extended to consider the case of an upward-sloping domestic supply curve of funds and congestion externalities. It is shown, in particular, that opening the economy to unrestricted inflows of capital may magnify the welfare cost of existing distortions, such as congestion externalities or deposit insurance.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
6782.
Length: Date of creation: Nov 1998 Date of revision: Handle: RePEc:nbr:nberwo:6782
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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.:
Jonathan Eaton & Mark Gersovitz & Joseph E. Stiglitz, 1986.
"The Pure Theory of Country Risk,"
NBER Working Papers
1894, National Bureau of Economic Research, Inc.
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Jonathan Eaton & Mark Gersovitz & Joseph E. Stiglitz, 1991.
"The Pure Theory of Country Risk,"
NBER Chapters,
in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 391-435
National Bureau of Economic Research, Inc.
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