TY  - JOUR
AU  - Agenor,Pierre-Richard
AU  - Aizenman,Joshua
TI  - Volatility and the Welfare Costs of Financial Market Integration
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 6782
PY  - 1998
Y2  - November 1998
UR  - http://www.nber.org/papers/w6782
L1  - http://www.nber.org/papers/w6782.pdf
N1  - Author contact info:
Pierre-Richard Agenor
School of Social Sciences, University of Mancheste
Manchester M139PL, United Kingdom
E-Mail: Pierre-richard.Agenor@manchester.ac.uk

Joshua Aizenman
Economics and SIR
USC
University Park
Los Angeles, CA 90089-0043
Tel: 213-740-4066
E-Mail: aizenman@usc.edu
AB  - This paper examines the effect of volatility on the costs and benefits of financial market integration.  The basic framework combines the costly state verification model and the contract enforceability approach.  The welfare effects of financial market integration are assessed by comparing welfare under financial autarky and financial openness -- under which foreign banks, characterized by lower costs of intermediation and a lower markup rate, have free access to domestic capital markets.  The analysis shows that financial integration may be welfare reducing if world interest rates under openness are highly volatile.  The basic framework is then extended to consider the case of an upward-sloping domestic supply curve of funds and congestion externalities.  It is shown, in particular, that opening the economy to unrestricted inflows of capital may magnify the welfare cost of existing distortions, such as congestion externalities or deposit insurance.
ER  -