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Thresholds in the Process of International Financial Integration

46 Pages Posted: 31 May 2009  

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

M. Ayhan Kose

Development Prospects Group at the World Bank

Ashley D. Taylor

World Bank

Multiple version iconThere are 4 versions of this paper

Date Written: May 21, 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 tradeoff 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.

Keywords: international finance, developing countries, financial institutions, global economics

Suggested Citation

Prasad, Eswar S. and Kose, M. Ayhan and Taylor, Ashley D., Thresholds in the Process of International Financial Integration (May 21, 2009). Brookings Global Economy and Development Working Paper No. 35. Available at SSRN: https://ssrn.com/abstract=1408154 or http://dx.doi.org/10.2139/ssrn.1408154

Eswar Prasad (Contact Author)

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

440 Warren Hall
Ithaca, NY 14853
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HOME PAGE: http://prasad.aem.cornell.edu

Cornell University - Department of Economics ( email )

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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
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M. Kose

Development Prospects Group at the World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Ashley Taylor

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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