Volatility and the Welfare Costs of Financial Market Integration

Pierre-Richard Agénor and Joshua Aizenman

No 6782, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper examines the effect of volatility on the costs and benefits of financial market integration. The basic framework combines the costly state verification model and the contract enforceability approach. The welfare effects of financial market integration are assessed by comparing welfare under financial autarky and financial openness -- under which foreign banks, characterized by 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 basic framework is then extended to consider the case of an upward-sloping domestic supply curve of funds and congestion externalities. It is shown, in particular, that opening the economy to unrestricted inflows of capital may magnify the welfare cost of existing distortions, such as congestion externalities or deposit insurance.

JEL-codes: F36 I31 (search for similar items in EconPapers)
Date: 1998-11
Note: ITI
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

Published as The Asian Financial Crisis, Agenor, P.R., M. Miller and A. Weber, eds., Cambridge: Cambridge University Press, 1999, pp. 195-225.

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Working Paper: Volatility and the welfare costs of financial market integration (1998)
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