The Impact of Financial Integration on Investment and External Financing

Abstract:     
This paper presents a two-country model of investment and external financing that incorporates heterogeneous firms into general equilibrium. The model is solved in closed form and shows that financial integration leads to: (i) a change in the portfolio allocation of the investors yielding better risk-diversification; (ii) an increase in aggregate investment; (iii) a reorganization of the real economy with an increase of investment for the most productive firms (through domestic and foreign external financing) and the exit of the least productive ones; (iv) a change in the financing patterns with an increase (resp. a decrease) of the share of market finance in total external finance in the industries with increasing (resp. decreasing) returns to scale in production.

Number of Pages in PDF File: 15

Keywords: Financial structure, heterogeneous firms, financial integration, foreign bank entry, cross-listing, home bias

JEL Classification: F36, F43, L25

working papers series