Financial Integration, Savings Gluts, and Asset Price Booms
The B.E. Journal of Theoretical Economics, Forthcoming
37 Pages Posted: 22 Aug 2013 Last revised: 12 Aug 2020
Date Written: August 10, 2020
Capital outflows after financial integration can lead to simultaneous increases in the national savings rate and asset prices in an economy with substantial financing costs. Under autarky, firms invest in risky capital while facing a borrowing constraint that creates a need for precautionary savings. Financial integration provides firms with access to foreign risk-free assets and results in two effects: a substitution effect, whereby firms divert some investments to foreign assets and cause capital outflows; and a wealth effect, whereby they grow richer in equilibrium and thus demand more domestic capital. Savings gluts and asset price booms occur when the wealth effect dominates.
Keywords: dynamic portfolio choice, financial integration, costly financing
JEL Classification: G11, G15, F36, E22
Suggested Citation: Suggested Citation