Financial Integration, Growth, and Volatility

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.The aim of this paper is to evaluate the welfare gains from financial integration for developing and emerging market economies. To do so, we build a stochastic endogenous growth model for a small open economy that can (i) borrow from the rest of the world, (ii) invest in foreign assets, and (iii) receive foreign direct investment (FDI). The model is calibrated on 32 emerging market and developing economies for which we evaluate the upper bound for the welfare gain from financial integration. For plausible values of preference parameters and actual levels of financial integration, the mean welfare gain from financial integration is about 10 percent of initial wealth. Compared with financial autarky, actual levels of financial integration translate into slightly higher annual growth rates (around 0.4 percentage point per year.) JEL Classification Numbers: E13, F20, F36, F3, F43, O41

Government size and openness revisited: the case of financial globalization

“…In contrast, less developed countries tend to see only modest gains from financial integration, if any. These more pessimistic findings for developing countries are broadly confirmed by Gourinchas and Jeanne (2004), Epaulard and Pommeret (2005), and to a somewhat lesser extent by Bekaert et al (2006).…”

Solving General Equilibrium Models with Incomplete Markets and Many Assets

“…Y t is a vector of non-predetermined variables at time t. It includes consumption, dividends, and asset prices. Given our formulation in (13) and (14), a solution to the model is characterized by a decision rule for the non-predetermined variables…”

“…To understand why our formulation in (13) and (14) allows for conditional heteroskedasticy in the dynamics of the state vector, we return to the model. In particular, let us focus on the log-linearized equations arising from the households' first order conditions and budget constraint.…”

“…When markets are incomplete, by contrast, it is not possible to characterize the equilibrium dynamics of the economy without including household wealth in the state vector X t . As a consequence, in this setting it is necessary to allow for conditional heteroskedasticity in the dynamics of the state variable as our formulation in (13) and 14does.…”

Growth and Welfare Gains from Financial Integration Under Model Uncertainty

“…This procedure leaves us with a sample of 85 countries with observations from 1962 to 2011, yielding a total of 4000 observations. 18 Table 2 of KPT 2006). This is possibly due to the fact that our data set extends theirs by 11 years and thus our estimation benefits from the additional data.…”