The aim of this thesis is to analyse international financial integration. Chapter 2 investigates the determinants of international financial integration. Variables including the capital control policy dummy variable, openness to international trade, domestic credit and economic growth are candidates for explaining variation in the degree of international financial integration. Chapter 3 analyses cointegration between the US and several European Union equity markets. Between 1993 and 1998, there is mixed evidence of cointegration ties with the US equity market. Over the period covering the introduction of the euro, most of the European markets did not show any evidence of cointegration with the US market. Granger causality tests reveal significant causality running from the US to the European markets. Chapter 4 estimates time series of market and idiosyncratic volatilities for the firms composing the index DJ Eurostoxx 50 following the volatility decomposition method of Campbell et al. (2001). There was a positive trend in both market and firm-level volatility and average correlation among firms has increased. This contrasts with the US evidence in Campbell et al. (2001) of a strong positive trend in firm-level volatility, no trend in market volatility and a decrease in the average correlation. Results confirm a statistically significant market risk-return trade-off and that firm-level volatility has no predictive power for subsequent market returns. Chapter 5 analyses the link between FDI and economic growth using panel data. FDI has a stronger positive impact on economic growth in countries with higher levels of education attainment, those that are more open to international trade, have better stock market development and lower rates of population growth and levels of risk. Chapter 6 investigates the determinants of the home bias. Results indicate that capital controls and transaction costs are factors driving the home bias of Australian equity portfolio investment. The home bias lessens if the bilateral trade is higher. Australian investors invest a higher share of their portfolio in countries with better institutions and larger market size.

The aim of this thesis is to analyse international financial integration. Chapter 2 investigates the determinants of international financial integration. Variables including the capital control policy dummy variable, openness to international trade, domestic credit and economic growth are candidates for explaining variation in the degree of international financial integration. Chapter 3 analyses cointegration between the US and several European Union equity markets. Between 1993 and 1998, there is mixed evidence of cointegration ties with the US equity market. Over the period covering the introduction of the euro, most of the European markets did not show any evidence of cointegration with the US market. Granger causality tests reveal significant causality running from the US to the European markets. Chapter 4 estimates time series of market and idiosyncratic volatilities for the firms composing the index DJ Eurostoxx 50 following the volatility decomposition method of Campbell et al. (2001). There was a positive trend in both market and firm-level volatility and average correlation among firms has increased. This contrasts with the US evidence in Campbell et al. (2001) of a strong positive trend in firm-level volatility, no trend in market volatility and a decrease in the average correlation. Results confirm a statistically significant market risk-return trade-off and that firm-level volatility has no predictive power for subsequent market returns. Chapter 5 analyses the link between FDI and economic growth using panel data. FDI has a stronger positive impact on economic growth in countries with higher levels of education attainment, those that are more open to international trade, have better stock market development and lower rates of population growth and levels of risk. Chapter 6 investigates the determinants of the home bias. Results indicate that capital controls and transaction costs are factors driving the home bias of Australian equity portfolio investment. The home bias lessens if the bilateral trade is higher. Australian investors invest a higher share of their portfolio in countries with better institutions and larger market size.

This dissertation addresses three issues in international macroeconomics. The first chapter examines optimal portfolio decisions in a monetary open economy DSGE model. In a complete market environment, Engel and Matsumoto (2005) find that sticky price can generate equity home bias. However, their result is sensitive to the structure of the financial market. In an incomplete market environment, we find “super home bias” in the equilibrium equity portfolio, which casts doubt on the ability of sticky price in describing the observed equity portfolios. We further show that introducing sticky wages helps to match the data. The second chapter analyzes the welfare impact of financial integration in a standard monetary open-economy model. Financial integration may have negative effects on welfare if integration occurs in the presence of nominal price rigidities and constraints on the efficient use of monetary policy. The reason is that financial integration leads to excessive terms of trade volatilities. From a policy perspective, the model implies that developing economies that are experiencing financial integration may attempt to alleviate the welfare cost of integration by stabilizing the exchange rate. This prediction is consistent with the widespread reluctance to following freely floating exchange rates among these economies. On the other hand, for advanced economies that have the ability to operate efficient inflation targeting monetary policies, financial integration is always beneficial. Thus, the model accounts for the observed acceleration in cross-border asset trade among advanced economies in the early 1990s as it was mainly the industrial countries that switched to an inflation targeting regime at the time. The third chapter uses an open-economy neoclassical growth model to explain the saving and investment behavior of the U.S. and a group of other OECD countries. We find that while the model explains investment quite well, it tends to overpredict U.S saving and underpredict saving in the rest of the world. We show that the closed-economy version of the model also predicts saving accurately but that is only because it imposes equality between saving and investment. In effect, the model explains investment not saving behavior.

This dissertation addresses three issues in international macroeconomics. The first chapter examines optimal portfolio decisions in a monetary open economy DSGE model. In a complete market environment, Engel and Matsumoto (2005) find that sticky price can generate equity home bias. However, their result is sensitive to the structure of the financial market. In an incomplete market environment, we find “super home bias” in the equilibrium equity portfolio, which casts doubt on the ability of sticky price in describing the observed equity portfolios. We further show that introducing sticky wages helps to match the data. The second chapter analyzes the welfare impact of financial integration in a standard monetary open-economy model. Financial integration may have negative effects on welfare if integration occurs in the presence of nominal price rigidities and constraints on the efficient use of monetary policy. The reason is that financial integration leads to excessive terms of trade volatilities. From a policy perspective, the model implies that developing economies that are experiencing financial integration may attempt to alleviate the welfare cost of integration by stabilizing the exchange rate. This prediction is consistent with the widespread reluctance to following freely floating exchange rates among these economies. On the other hand, for advanced economies that have the ability to operate efficient inflation targeting monetary policies, financial integration is always beneficial. Thus, the model accounts for the observed acceleration in cross-border asset trade among advanced economies in the early 1990s as it was mainly the industrial countries that switched to an inflation targeting regime at the time. The third chapter uses an open-economy neoclassical growth model to explain the saving and investment behavior of the U.S. and a group of other OECD countries. We find that while the model explains investment quite well, it tends to overpredict U.S saving and underpredict saving in the rest of the world. We show that the closed-economy version of the model also predicts saving accurately but that is only because it imposes equality between saving and investment. In effect, the model explains investment not saving behavior.

This dissertation addresses three issues in international macroeconomics. The first chapter examines optimal portfolio decisions in a monetary open economy DSGE model. In a complete market environment, Engel and Matsumoto (2005) find that sticky price can generate equity home bias. However, their result is sensitive to the structure of the financial market. In an incomplete market environment, we find “super home bias” in the equilibrium equity portfolio, which casts doubt on the ability of sticky price in describing the observed equity portfolios. We further show that introducing sticky wages helps to match the data. The second chapter analyzes the welfare impact of financial integration in a standard monetary open-economy model. Financial integration may have negative effects on welfare if integration occurs in the presence of nominal price rigidities and constraints on the efficient use of monetary policy. The reason is that financial integration leads to excessive terms of trade volatilities. From a policy perspective, the model implies that developing economies that are experiencing financial integration may attempt to alleviate the welfare cost of integration by stabilizing the exchange rate. This prediction is consistent with the widespread reluctance to following freely floating exchange rates among these economies. On the other hand, for advanced economies that have the ability to operate efficient inflation targeting monetary policies, financial integration is always beneficial. Thus, the model accounts for the observed acceleration in cross-border asset trade among advanced economies in the early 1990s as it was mainly the industrial countries that switched to an inflation targeting regime at the time. The third chapter uses an open-economy neoclassical growth model to explain the saving and investment behavior of the U.S. and a group of other OECD countries. We find that while the model explains investment quite well, it tends to overpredict U.S saving and underpredict saving in the rest of the world. We show that the closed-economy version of the model also predicts saving accurately but that is only because it imposes equality between saving and investment. In effect, the model explains investment not saving behavior. / Arts, Faculty of / Vancouver School of Economics / Graduate

Yes / We provide new evidence that current account balances in Greece, Portugal and Spain have become non-stationary after the adoption of the euro implying that there is no long-run stable relationship between savings and investment contrary to the Feldstein-Horioka puzzle. This can be taken as evidence of unsustainable current account balances and loss of solvency for the underlying economies. Using the ARDL methodology we also report a statistical association between fiscal balances and current account balances which implies that fiscal austerity can help these economies to reduce their current account deficits and restore their competitiveness. Our empirical evidence also suggests a particularly strong significant negative association between domestic investment and current account deficits. The magnitude of this latter effect may have important policy implications concerning the ways in which investment is financed to improve external competitiveness.