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Financial integration and asset returns

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  • Martin, Philippe
  • Rey, Helene

Abstract

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 to higher demand for assets issued on those markets, higher asset price and greater 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.

Suggested Citation

  • Martin, Philippe & Rey, Helene, 2000. "Financial integration and asset returns," LSE Research Online Documents on Economics 20201, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:20201
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    References listed on IDEAS

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    More about this item

    Keywords

    Financial integration; asset trade; transaction costs; cross-listing;

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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