Working Paper: CEPR ID: DP3852
Authors: Viral V. Acharya; Alberto Bisin
Abstract: We study two-period pure-exchange Capital Asset Pricing Model (CAPM) economies, for given degrees of incompleteness of financial markets and given degrees of restricted participation of agents in the markets. We characterize the optimal financial market structure of this economy, as well as efficient financial innovations consisting of both the introduction of new assets and the integration of segmented markets. We show that the optimal financial market structures maximize a simple criterion that captures the dispersion of the ?betas? of the participating agents. Our results imply that, in contrast with the prescription of the Optimal Currency Area literature, maximal advantage from the integration of financial markets arises for those economic regions whose endowment processes are minimally or negatively correlated. Moreover, we show that some coordination of the innovation process, e.g., in the form of consolidation of exchanges, is likely to be desirable when the integrating economies have segmented asset markets.
Keywords: CAPM; Decentralizability; Financial Integration; Incomplete Markets; Restricted Participation; Security Design
JEL Codes: D52; D58; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal financial market structures (G19) | maximize the dispersion of betas (C46) |
| maximize the dispersion of betas (C46) | enhances welfare (I30) |
| financial innovations (O16) | positive welfare outcomes (I31) |
| financial innovations (O16) | high degree of beta dispersion (C46) |
| financial integration (F30) | beneficial for welfare (D69) |
| order of innovations (O35) | affects welfare (I38) |
| financial market structure (G10) | welfare of agents (I30) |