An Intertemporal Model of Segmentation (Reprint 056)

Suleyman Basak

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: This paper develops an intertemporal model of international capital market segmentation. Within the model, under various forms of segmentation/integration, the equilibrium asset prices and allocations, the risk-free interest rate, and the intertemporal consumption behavior and welfares of two countries are derived and compared. It is shown that the equilibrium interest rate is increased on integration, and that integrating markets may be significantly welfare decreasing for one of the countries. Conditions that may lead to a decrease in welfare are investigated. The conclusions as to the effects of segmentation on asset prices in the mean-variance model of the existing finance segmentation literature are also shown to break down in an intertemporal model.

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