Optimal Financial Integration and Security Design

42 Pages Posted: 30 May 2003

See all articles by Viral V. Acharya

Viral V. Acharya

New York University (NYU) - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Alberto Bisin

New York University (NYU) - Department of Economics; New York University (NYU) - Center for Experimental Social Science (CESS); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2003

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: Security design, financial integration, decentralizability, incomplete markets, restricted participation, CAPM

JEL Classification: D52, D58, G12

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Bisin, Alberto, Optimal Financial Integration and Security Design (March 2003). Available at SSRN: https://ssrn.com/abstract=412027

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