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Volatility and the welfare costs of financial market integration

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  • Agenor, Pierre-Richard
  • Aizenman, Joshua

Abstract

The authors examine the effect of volatility on the costs and benefits of financial market integration. The authors use a basic framework that combines the costly state verification model and the contract enforceability approach. They assess the welfare effects of financial market integration by comparing welfare under financial market integration and comparing welfare under financial autarky and financial openness. Under financial openness, foreign banks, which have 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 authors extend the basic framework in various directions. They show that opening the economy to unrestricted inflows of capital, in particular, may magnify the welfare cost of existing distortion, such as congestion externalities or deposit insurance.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1974.

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Date of creation: 30 Sep 1998
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Handle: RePEc:wbk:wbrwps:1974

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Keywords: Banks&Banking Reform; Economic Theory&Research; Environmental Economics&Policies; Financial Intermediation; Financial Economics;

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References

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  1. Pierre-Richard Agenor & Joshua Aizenman, 1997. "Contagion and Volatility with Imperfect Credit Markets," NBER Working Papers 6080, National Bureau of Economic Research, Inc.
  2. 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.
  3. Elhanan Helpman, 1988. "The Simple Analytics of Debt-Equity Swaps," NBER Working Papers 2771, National Bureau of Economic Research, Inc.
  4. Demirguc-Kunt, Asli & Huizinga, Harry, 1998. "Determinants of commercial bank interest margins and profitability : some international evidence," Policy Research Working Paper Series, The World Bank 1900, The World Bank.
  5. 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.
  6. 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.
  7. Paul Milgrom & John Roberts, 1998. "Limit Pricing and Entry Under Incomplete Information: An Equilibrium Analysis," Levine's Working Paper Archive 245, David K. Levine.
  8. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
  9. Jeremy I. Bulow & Kenneth Rogoff, 1987. "A Constant Recontracting Model of Sovereign Debt," NBER Working Papers 2088, National Bureau of Economic Research, Inc.
  10. 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.
  11. Jonathan Eaton & Mark Gersovitz & Joseph E. Stiglitz, 1986. "The Pure Theory of Country Risk," NBER Working Papers 1894, National Bureau of Economic Research, Inc.
  12. Claessens, Stijn & Demirguc-Kunt, Asli & Huizinga, Harry, 1998. "How does foreign entry affect the domestic banking market?," Policy Research Working Paper Series, The World Bank 1918, The World Bank.
  13. Stephen D. Williamson, 1984. "Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing," Working Papers, Queen's University, Department of Economics 583, Queen's University, Department of Economics.
  14. 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.
  15. Joshua Aizenman, 2003. "Capital Mobility In A Second--Best World: Moral Hazard With Costly Financial Intermediation," Review of International Economics, Wiley Blackwell, Wiley Blackwell, vol. 11(1), pages 1-17, February.
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Citations

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Cited by:
  1. 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.
  2. 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.
  3. 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.
  4. Joshua Aizenman & Stephen Turnovsky, 1999. "Reserve Requirements on Sovereign Debt in the Presence of Moral Hazard -- on Debtors or Creditors?," Discussion Papers in Economics at the University of Washington, Department of Economics at the University of Washington 0044, Department of Economics at the University of Washington.
  5. 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.
  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. Agenor, Pierre-Richard, 2001. "Benefits and costs of international financial integration : theory and facts," Policy Research Working Paper Series, The World Bank 2699, The World Bank.

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