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Institutional quality and cross-border asset trade: are banks less worried about diversification abroad?

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  • Eleonora Cavallaro
  • Eleonora Cutrini

Abstract

We build a model of cross-border asset trade where countries’ institutional quality impacts on the expected returns of the assets, and investors’ sensitivity to quality varies with their financial stress condition. Changes in “perceived quality†influence the portfolio allocation decisions and the patterns of international financial flows over time. We run econometric estimations for cross-border bank flows from advanced to emerging economies, over the period 2005-2014. We find that deteriorating conditions in financial markets, before the crisis, lead to higher demand for institutional quality. A strong regulatory environment is perceived as a protection against adverse future losses, and countries with goods institutions are less exposed to capital retrenchment. In the aftermath of the crisis, the liquidity easing in advanced economies drives down concerns for EMEs' developments, boosting flows and challenging EMEs' ability to use capital controls to mitigate unbridled flows.

Suggested Citation

  • Eleonora Cavallaro & Eleonora Cutrini, 2018. "Institutional quality and cross-border asset trade: are banks less worried about diversification abroad?," Working Papers 186, University of Rome La Sapienza, Department of Public Economics.
  • Handle: RePEc:sap:wpaper:wp186
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    References listed on IDEAS

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    More about this item

    Keywords

    Asset trade; Distance; quality; International financial flows; Emerging markets; Economic integration;

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • G1 - Financial Economics - - General Financial Markets
    • O5 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies

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