Financial Integration and Business Cycle Synchronization

Kalemli-Ozcan, Sebnem, Elias Papaioannou and Peydró-Alcalde, José Luis

No 7292, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Standard theory predicts that financial integration leads to a lower degree of business cycle synchronization. Surprisingly, cross-country studies find the opposite. Our contribution is to document the theoretically predicted negative effect of financial integration on business cycle synchronization as a robust regularity. We use a confidential dataset on banks' international bilateral exposure over the past three decades in a panel of twenty developed countries. The rich panel structure allows us to control for time-invariant country-pair factors and global trends that affect both financial integration and business cycle patterns. In contrast to previous empirical work we find that a higher degree of financial integration is associated with less synchronized output cycles. We also employ two distinct instrumental variable approaches to identify the one-way effect of integration on synchronization. These specifications reveal that the component of banking integration predicted by legislative-regulatory harmonization policies and the nature of the bilateral exchange rate regime has a negative effect on output synchronization.

Keywords: Banks; Business Cycles; Co-movement; Financial Integration; Financial Regulation (search for similar items in EconPapers)
JEL-codes: E32 F15 F36 G21 O16 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-cba, nep-mac, nep-opm and nep-reg
Date: 2009-05
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