Impediments to Financial Trade: Theory and Measurement
64 Pages Posted: 15 Aug 2015
Date Written: January 1, 2015
We propose a tractable model of an informationally inefficient market. We show the equivalence between our model and a substantially simpler model whereby investors face distortive investment taxes depending both on their identity and the asset class. We use this equivalence to assess existing approaches to inferring whether individual investors have informational advantages. We also develop a methodology of inferring the magnitude of the frictions (implicit taxes) that impede financial trade. We illustrate the methodology by using data on cross-country portfolio holdings and returns to quantify these frictions, and locate the directions in which financial trade seems to be especially impeded. We argue that our measure of frictions contains useful information for the sources of failure of frictionless models, and it helps in studying whether certain factors (such as the size of the financial sector) are associated with lower financial frictions.
Keywords: Financial frictions, Asset Pricing, Inefficient Markets, Performance Evaluation, Crossborder
JEL Classification: G12, G14, G15
Suggested Citation: Suggested Citation