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International Capital Flows in a World of Greater Financial Integration

Author

Listed:
  • Viktoria Hnatkovska
  • Martin Evans

    (Economics Georgetown University)

Abstract

International capital flows have increased dramatically since the 1980s, with much of the increase being due to trade in equity and debt markets. Such developments are often attributed to the increased integration of world financial markets. We present a model that allows us to examine how greater integration in world financial markets affects the structure of asset ownership and the behavior of international capital flows. Our model predicts that international capital flows are large (in absolute value) and very volatile during the early stages of financial integration when international asset trading is concentrated in bonds. As integration progresses and households gain access to world equity markets, the size and volatility of international bond flows fall dramatically but continue to exceed the size and volatility of international equity flows. We also find that variations in the equity risk premia account for almost all of the international portfolio flows in bonds and equities. We argue that both effects arise naturally as a result of increased risk sharing facilitated by greater financial integration. The paper also makes a methodological contribution to the literature on dynamic general equilibrium asset-pricing. We present a new technique for solving a dynamic general equilibrium model with production, portfolio choice and incomplete markets

Suggested Citation

  • Viktoria Hnatkovska & Martin Evans, 2005. "International Capital Flows in a World of Greater Financial Integration," Computing in Economics and Finance 2005 419, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:419
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    References listed on IDEAS

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    More about this item

    Keywords

    Portfolio Choice; Financial Integration; Incomplete Markets;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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