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Volatility and the welfare costs of financial market integration


  • Agenor, Pierre-Richard
  • Aizenman, Joshua


The authors examine the effect of volatility on the costs and benefits of financial market integration. The authors use a basic framework that combines the costly state verification model and the contract enforceability approach. They assess the welfare effects of financial market integration by comparing welfare under financial market integration and comparing welfare under financial autarky and financial openness. Under financial openness, foreign banks, which have lower costs of intermediation and a lower markup rate, have free access to domestic capital markets. The analysis shows that financial integration may be welfare-reducing if world interest rates under openness are highly volatile. The authors extend the basic framework in various directions. They show that opening the economy to unrestricted inflows of capital, in particular, may magnify the welfare cost of existing distortion, such as congestion externalities or deposit insurance.

Suggested Citation

  • Agenor, Pierre-Richard & Aizenman, Joshua, 1998. "Volatility and the welfare costs of financial market integration," Policy Research Working Paper Series 1974, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1974

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    References listed on IDEAS

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    4. Pierre-Richard Agénor & Joshua Aizenman, 1998. "Contagion and Volatility with Imperfect Credit Markets," IMF Staff Papers, Palgrave Macmillan, vol. 45(2), pages 207-235, June.
    5. Joshua Aizenman, 2003. "Capital Mobility In A Second--Best World: Moral Hazard With Costly Financial Intermediation," Review of International Economics, Wiley Blackwell, vol. 11(1), pages 1-17, February.
    6. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
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    8. Claessens, Stijn & Demirguc-Kunt, Asli & Huizinga, Harry, 1998. "How does foreign entry affect the domestic banking market?," Policy Research Working Paper Series 1918, The World Bank.
    9. Bulow, Jeremy & Rogoff, Kenneth, 1989. "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 155-178, February.
    10. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
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    13. Boyd, John H & Smith, Bruce D, 1994. "How Good Are Standard Debt Contracts? Stochastic versus Nonstochastic Monitoring in a Costly State Verification Environment," The Journal of Business, University of Chicago Press, vol. 67(4), pages 539-561, October.
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    Cited by:

    1. Joshua Aizenman & Stephen J. Turnovsky, 2002. "Reserve Requirements on Sovereign Debt in the Presence of Moral Hazard -- on Debtors or Creditors?," Economic Journal, Royal Economic Society, vol. 112(476), pages 107-132, January.
    2. Keith Blackburn & Dimitrios Varvarigos, 2005. "Growth, Uncertainty and Finance," The School of Economics Discussion Paper Series 0525, Economics, The University of Manchester.
    3. Jorge A. Chan-Lau & Zhaohui Chen, 1998. "Financial Crisis and Credit Crunch as a Result of Inefficient Financial Intermediation—with Reference to the Asian Financial Crisis," International Finance 9804001, EconWPA, revised 22 Sep 1998.
    4. Eduardo Walker & Fernando Lefort, 2002. "Pension Reform And Capital Markets: Are There Any (Hard) Links?," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 5(2), pages 77-149.
    5. Dimitrios Varvarigos & Keith Blackburn, 2005. "Growth, Uncertainty and Finance," Money Macro and Finance (MMF) Research Group Conference 2005 12, Money Macro and Finance Research Group.
    6. K Blackburn & D Varvarigos, 2005. "Growth, Uncertainty and Finance," Centre for Growth and Business Cycle Research Discussion Paper Series 48, Economics, The Univeristy of Manchester.
    7. Pierre-Richard AgÈnor, 2003. "Benefits and Costs of International Financial Integration: Theory and Facts," The World Economy, Wiley Blackwell, vol. 26(8), pages 1089-1118, August.
    8. Oliver Williams & Stephen Satchell, 2011. "Social welfare issues of financial literacy and their implications for regulation," Journal of Regulatory Economics, Springer, vol. 40(1), pages 1-40, August.

    More about this item


    Banks&Banking Reform; Economic Theory&Research; Environmental Economics&Policies; Financial Intermediation; Financial Economics;

    JEL classification:

    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • I31 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - General Welfare, Well-Being


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