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Volatility and the Welfare Costs of Financial Market Integration

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  • Pierre-Richard Agenor
  • Joshua Aizenman

Abstract

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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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6782.

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Date of creation: Nov 1998
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Publication status: published as The Asian Financial Crisis, Agenor, P.R., M. Miller and A. Weber, eds., Cambridge: Cambridge University Press, 1999, pp. 195-225.
Handle: RePEc:nbr:nberwo:6782

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  1. Joshua Aizenman, 2003. "Capital Mobility In A Second--Best World: Moral Hazard With Costly Financial Intermediation," Review of International Economics, Wiley Blackwell, vol. 11(1), pages 1-17, February.
  2. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State, Chicago - Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
  3. 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.
  4. Claessens, Stijn & Demirguc-Kunt, Asli & Huizinga, Harry, 1998. "How does foreign entry affect the domestic banking market?," Policy Research Working Paper Series 1918, The World Bank.
  5. Maurice Obstfeld., 1993. "Risk-Taking, Global Diversification, and Growth," Center for International and Development Economics Research (CIDER) Working Papers, University of California at Berkeley C93-016, University of California at Berkeley.
  6. Milgrom, Paul & Roberts, John, 1982. "Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis," Econometrica, Econometric Society, Econometric Society, vol. 50(2), pages 443-59, March.
  7. Pierre-Richard Agenor & Joshua Aizenman, 1997. "Contagion and Volatility with Imperfect Credit Markets," NBER Working Papers 6080, National Bureau of Economic Research, Inc.
  8. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, American Economic Association, vol. 79(1), pages 14-31, March.
  9. Demirguc, Asli & Huizinga, Harry, 1999. "Determinants of Commercial Bank Interest Margins and Profitability: Some International Evidence," World Bank Economic Review, World Bank Group, World Bank Group, vol. 13(2), pages 379-408, May.
  10. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
  11. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, Elsevier, vol. 21(2), pages 265-293, October.
  12. Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, Elsevier, vol. 18(2), pages 159-179, September.
  13. Boyd, John H & Smith, Bruce D, 1994. "How Good Are Standard Debt Contracts? Stochastic versus Nonstochastic Monitoring in a Costly State Verification Environment," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 67(4), pages 539-61, October.
  14. Elhanan Helpman, 1988. "The Simple Analytics of Debt-Equity Swaps," NBER Working Papers 2771, National Bureau of Economic Research, Inc.
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Cited by:
  1. Eduardo Walker & Fernando Lefort, 2002. "Pension Reform And Capital Markets: Are There Any (Hard) Links?," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 5(2), pages 77-149.
  2. Dimitrios Varvarigos & Keith Blackburn, 2005. "Growth, Uncertainty and Finance," Money Macro and Finance (MMF) Research Group Conference 2005, Money Macro and Finance Research Group 12, Money Macro and Finance Research Group.
  3. Joshua Aizenman & Stephen J. Turnovsky, 2002. "Reserve Requirements on Sovereign Debt in the Presence of Moral Hazard -- on Debtors or Creditors?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 112(476), pages 107-132, January.
  4. Pierre-Richard AgÈnor, 2003. "Benefits and Costs of International Financial Integration: Theory and Facts," The World Economy, Wiley Blackwell, vol. 26(8), pages 1089-1118, 08.
  5. Oliver Williams & Stephen Satchell, 2011. "Social welfare issues of financial literacy and their implications for regulation," Journal of Regulatory Economics, Springer, Springer, vol. 40(1), pages 1-40, August.
  6. K Blackburn & D Varvarigos, 2005. "Growth, Uncertainty and Finance," Centre for Growth and Business Cycle Research Discussion Paper Series, Economics, The Univeristy of Manchester 48, Economics, The Univeristy of Manchester.
  7. Jorge A. Chan-Lau & Zhaohui Chen, 1998. "Financial Crisis and Credit Crunch as a Result of Inefficient Financial Intermediation—with Reference to the Asian Financial Crisis," International Finance, EconWPA 9804001, EconWPA, revised 24 Apr 1998.

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