Thresholds in the Process of International Financial Integration

50 Pages Posted: 29 Apr 2009  

M. Ayhan Kose

Development Prospects Group at the World Bank

Eswar S. Prasad

Cornell University - Dyson School of Applied Economics and Management; Cornell University - Department of Economics; Brookings Institution; NBER; IZA Institute of Labor Economics

Ashley D. Taylor

World Bank

Multiple version iconThere are 4 versions of this paper

Date Written: April 2009

Abstract

The financial crisis has re-ignited the fierce debate about the merits of financial globalization and its implications for growth, especially for developing countries. The empirical literature has not been able to conclusively establish the presumed growth benefits of financial integration. Indeed, a new literature proposes that the indirect benefits of financial integration may be more important than the traditional financing channel emphasized in previous analyses. A major complication, however, is that there seem to be certain "threshold" levels of financial and institutional development that an economy needs to attain before it can derive the indirect benefits and reduce the risks of financial openness. In this paper, we develop a unified empirical framework for characterizing such threshold conditions. We find that there are clearly identifiable thresholds in variables such as financial depth and institutional quality -- the cost-benefit trade-off from financial openness improves significantly once these threshold conditions are satisfied. We also find that the thresholds are lower for foreign direct investment and portfolio equity liabilities compared to those for debt liabilities.

Suggested Citation

Kose, M. Ayhan and Prasad, Eswar S. and Taylor, Ashley D., Thresholds in the Process of International Financial Integration (April 2009). NBER Working Paper No. w14916. Available at SSRN: https://ssrn.com/abstract=1394823

M. Ayhan Kose (Contact Author)

Development Prospects Group at the World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Eswar S. Prasad

Cornell University - Dyson School of Applied Economics and Management ( email )

440 Warren Hall
Ithaca, NY 14853
United States

HOME PAGE: http://prasad.aem.cornell.edu

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
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Brookings Institution ( email )

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NBER ( email )

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IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Ashley D. Taylor

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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