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International Capital Flows with Limited Commitment and Incomplete Markets

Jurgen von Hagen (vonhagen@uni-bonn.de) and Haiping Zhang (zhanghaiping2001@yahoo.com)
Additional contact information
Jurgen von Hagen: University of Bonn, Indiana University and CEPR. Lennestrasse. 37, D-53113 Bonn, Germany.

No 17-2011, Working Papers from Singapore Management University, School of Economics

Abstract: Recent literature has proposed two alternative types of financial frictions, i.e., limited commitment and incomplete markets, to explain the patterns of international capital flows between developed and developing countries observed in the past two decades. This paper integrates both types of frictions into a two-country overlapping-generations framework to facilitate a direct comparison of their e ects. In our model, limited commitment distorts the investment made by agents with different productivity, which creates a wedge between the interest rates on equity capital vs. credit capital; while incomplete markets distort the investment among projects with different riskiness, which creates a wedge between the risk-free rate and the mean rate of return to risky capital. We show that the two approaches are observationally equivalent with respect to their implications for international capital flows, production eciency, and aggregate output.

Keywords: financial development; financial frictions; foreign direct investment; incomplete markets; limited commitment; international capital flows (search for similar items in EconPapers)
JEL-codes: E44 F41 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2011-12
New Economics Papers: this item is included in nep-dge, nep-mac, nep-opm and nep-sea
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Citations: View citations in EconPapers (2)

Published in SMU Economics and Statistics Working Paper Series

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Related works:
Working Paper: International Capital Flows with Limited Commitment and Incomplete Markets (2012) Downloads
Working Paper: International Capital Flows with Limited Commitment and Incomplete Markets (2012) Downloads
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