Working Paper: CEPR ID: DP2232
Authors: Philippe Martin; Hélène Rey
Abstract: The paper presents a two-country macroeconomic model in which the number of financial assets is endogenous. Imperfect substitutability of assets and international transaction costs give a comparative advantage to large markets, because of demand effects. Agents have more incentives to undertake risky investments on those markets; they can also diversify risk at a lower cost. Prices of financial assets are higher in the large area because asset markets are broader. We also analyse the impact of domestic transaction costs and issuing costs on financial markets and returns. Our theory has important implications for the pattern of international trade in risky assets.
Keywords: International Macroeconomics; Asset Trade; Transaction Costs; Incomplete Markets
JEL Codes: F4; F12; G1; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| larger financial markets (G19) | higher asset prices (G19) |
| transaction costs (D23) | home bias (F23) |
| home bias (F23) | demand for domestic assets (E41) |
| demand for domestic assets (E41) | higher asset prices (G19) |
| larger financial area (G29) | more risky projects (G19) |
| more risky projects (G19) | enhanced risk-sharing opportunities (G19) |
| higher domestic transaction costs (D23) | lower asset prices (G19) |
| higher domestic transaction costs (D23) | higher returns (G12) |
| higher issuing costs (G24) | higher asset prices (G19) |
| higher issuing costs (G24) | lower returns (G19) |
| market size (L25) | asset pricing (G19) |
| market size (L25) | risk-sharing opportunities (D16) |