Why International Equity Inflows to Emerging Markets are Inefficient and Small Relative to International Debt Flows

23 Pages Posted: 14 Dec 2001 Last revised: 31 Aug 2022

See all articles by Assaf Razin

Assaf Razin

Tel Aviv University - Eitan Berglas School of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Efraim Sadka

Tel Aviv University - Eitan Berglas School of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute); IZA Institute of Labor Economics

Chi-Wa Yuen

The University of Hong Kong - School of Economics and Finance

Date Written: December 2001

Abstract

This paper considers the financing of investment in the presence of asymmetric information between the 'insiders' and the 'outsiders' of the firms in a small open economy. It establishes a well-defined capital structure for the economy as a whole with the following features: low-productivity firms rely on the equity market to finance investment at a relatively low level; medium-productivity firms do not invest at all; and high-productivity firms rely on the debt market to finance investment at a relatively high level. It is shown that the debt market is efficient, with respect to both its scope and the amount of investment that each firm makes. However, the equity market fails: its scope is too narrow and the investment each firm makes is too little. A corrective policy requires just one instrument which is rather unconventional: lump-sum subsidies to those firms that choose to equity-finance their investment (i.e., equity-market-contingent grants).

Suggested Citation

Razin, Assaf and Sadka, Efraim and Yuen, Chi-Wa, Why International Equity Inflows to Emerging Markets are Inefficient and Small Relative to International Debt Flows (December 2001). NBER Working Paper No. w8659, Available at SSRN: https://ssrn.com/abstract=294097

Assaf Razin (Contact Author)

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The University of Hong Kong - School of Economics and Finance ( email )

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