Open Market Essay

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Financial Globalization and Risk Sharing: Welfare Effects and the Optimality of Open Markets Charles A. Trzcinka Andrey D. Ukhov∗ January 2006 Abstract To study the welfare effects of investment barriers and the opening of markets to foreigners, we construct an equilibrium model of international asset pricing without agency costs that allows endogenous market participation among heterogeneous agents. Equilibrium prices and the set of participating and non-participating agents are jointly determined in equilibrium and the ability of agents to choose to participate in the market affects prices of domestic and foreign assets. We examine the welfare effects of non-participation and find that when a country moves from complete segmentation to open markets for foreigners, the cost of capital falls in the domestic market. This is consistent with empirical findings in the international asset pricing literature. Through the endogenous participation mechanism, our model is able to capture sources of economic growth. Contrary to previous models, however, we show that opening markets is not Pareto-optimal and we identify a class of domestic agents whose welfare is lower after the opening of markets. These finding have political economy interpretations and policy implications. JEL Classification: F3; G12; G15; G31; O16. Keywords: International asset pricing; Capital market integration and liberalization; International risk sharing; International capital market equilibrium; We would like to thank Andrew Abel, Gurdip Bakshi (discussant), Geert Bekaert, Craig Doidge, Janice Eberly, Albert S. “Pete” Kyle, Greg Udell, John Wald, Masahiro Watanabe, the participants of The Eleventh Assurant/Georgia Tech International Finance Conference and the participants of National Bureau of Economic Research 2005 Universities Research Conference: Structural Changes in the Global Economy:
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