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Why Do Emerging Economies Import Direct Investment and Export Savings? A Story of Financial Underdevelopment

  • Diego Valderrama

    (Federal Reserve Bank of San Francisco)

  • Katherine Smith

    (U.S. Naval Academy)

The net foreign asset positions (NFAP) of developing countries and emerging markets tend to be short equity and either short or long debt, while most industrial nations are long equity and short debt. This paper proposes that financial system inefficiencies associated with underdeveloped financial markets can explain this difference in the NFAPs. Financial system imperfections typically found in emerging markets and developing countries raise the cost of debt financing for domestic firms. This in turn leads to three distinct effects; a greater need for firms to precautionary save, increased vulnerability to foreign multinationals buy-outs, and a drastic limitation on the purchase of foreign firms. We extend a small open economy framework to study the financing decisions of firms operating under financial frictions. In equilibrium, we can obtain a large negative net equity position and a smaller negative net debt position as a result of incremental financing decisions of the firms, rationalizing the observed NFAP in most non-industrial economies.

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File URL: https://economicdynamics.org/meetpapers/2009/paper_1160.pdf
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Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 1160.

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Date of creation: 2009
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Handle: RePEc:red:sed009:1160
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. C. Bora Durdu & Enrique G. Mendoza & Marco Terrones, 2007. "Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Mercantilism: Working Paper 2007-10," Working Papers 18952, Congressional Budget Office.
  2. Smith, Katherine A. & Valderrama, Diego, 2009. "The composition of capital inflows when emerging market firms face financing constraints," Journal of Development Economics, Elsevier, vol. 89(2), pages 223-234, July.
  3. Ceyhun Bora Durdu & Enrique G. Mendoza & Marco E. Terrones, 2007. "Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Merchantilism," NBER Working Papers 13123, National Bureau of Economic Research, Inc.
  4. Miller, Darius P. & Puthenpurackal, John J., 2002. "The Costs, Wealth Effects, and Determinants of International Capital Raising: Evidence from Public Yankee Bonds," Journal of Financial Intermediation, Elsevier, vol. 11(4), pages 455-485, October.
  5. Arie Melnik & Doron Nissim, 2003. "Debt Issue Costs and Issue Characteristics in the Market for U.S. Dollar Denominated International Bonds," Review of Finance, European Finance Association, vol. 7(2), pages 277-296.
  6. Arie Melnik & Doron Nissim, 2003. "Debt issue costs and issue characteristics in the Eurobond market," ICER Working Papers 09-2003, ICER - International Centre for Economic Research.
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