Working Paper: CEPR ID: DP4060
Authors: Suleyman Basak; Benjamin Croitoru
Abstract: While financial markets have recently become more complete and international capital flows well liberalized, markets for goods remain segmented. To investigate how more complete security markets may relieve the effects of this segmentation, we examine a series of two-country economies with internationally segmented good markets, distinguished by the available financial securities. We show that, under heterogeneity within countries, the financial structure matters: even with internationally complete financial markets, risk sharing is limited and the equilibrium allocation may be inefficient, depending on the location of the securities. Sufficient conditions for efficiency include complete international financial markets together with liberalized international financial flows. Under these conditions, heterogeneous agents from the same country engage in ?financial shipping?, using securities as a substitute for the international shipment of goods. This allows them to partially circumvent the segmentation, allowing for efficient risk sharing.
Keywords: financial innovation; international capital flows; market segmentation; risk sharing
JEL Codes: F30; F36; G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial market structure (G19) | Risk sharing efficiency (D61) |
| Financial shipping (G19) | Risk sharing among heterogeneous agents (D82) |
| Lack of complete domestic financial market (F65) | Inefficiencies in consumption choices (D11) |
| International financial markets and unrestricted capital flows (F30) | Efficient risk sharing (G11) |
| Financial market structure (G19) | Pareto efficiency (D61) |