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Financial Integration and Business Cycle Synchronization

  • Kalemli-Ozcan, Sebnem
  • Papaioannou, Elias
  • Peydró, José Luis

Standard theory predicts that financial integration leads to a lower degree of business cycle synchronization. Surprisingly, cross-country studies find the opposite. Our contribution is to document the theoretically predicted negative effect of financial integration on business cycle synchronization as a robust regularity. We use a confidential dataset on banks' international bilateral exposure over the past three decades in a panel of twenty developed countries. The rich panel structure allows us to control for time-invariant country-pair factors and global trends that affect both financial integration and business cycle patterns. In contrast to previous empirical work we find that a higher degree of financial integration is associated with less synchronized output cycles. We also employ two distinct instrumental variable approaches to identify the one-way effect of integration on synchronization. These specifications reveal that the component of banking integration predicted by legislative-regulatory harmonization policies and the nature of the bilateral exchange rate regime has a negative effect on output synchronization.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7292.

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Date of creation: May 2009
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Handle: RePEc:cpr:ceprdp:7292
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