International Good Market Segmentation and Financial Innovation

Abstract:     
While financial markets have recently become more complete and international capital flows well liberalized, markets for goods remain segmented. To investigate how financial innovation and 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 risk-sharing may be limited even with complete financial markets, and that additional securities may be needed to reach an efficient equilibrium allocation; the location of these securities also profoundly affects the equilibrium. Key to this result is our assumption that there may be heterogeneity and imperfect risk-sharing within countries as well as across countries, a novelty of this work. Sufficient conditions for efficiency include complete international financial markets together with liberalized international financial flows. Under these conditions, heterogeneous agents from the same country may use securities as a substitute for the international shipment of goods. This allows them to partially circumvent the segmentation, allowing for efficient risk sharing.

Keywords: Market Segmentation, Financial Innovation, International Capital Flows, Dynamic Equilibrium

JEL Classification: F30, F36, G12, G15

Accepted Paper Series