Financial Integration, Savings Gluts, and Asset Price Booms

Capital outflows after financial integration can lead to simultaneous increases in the national savings rate and asset prices of 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...

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Bibliographic Details
Published in:The B.E. journal of theoretical economics 2021-01, Vol.21 (1), p.205-238
Main Authors: Feng, Felix Zhiyu, Lu, Will Jianyu, Zhu, Caroline H.
Format: Article
Language:English
Subjects:
costly financing
dynamic portfolio choice
E22
F36
financial integration
G11
G15
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Summary:Capital outflows after financial integration can lead to simultaneous increases in the national savings rate and asset prices of 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.
ISSN:1935-1704
1935-1704
DOI:10.1515/bejte-2018-0050