Universities Research Conference - Micro and Macroeconomic Effects of Financial Globalization

December 5-6, 2008
Ross Levine and Carlos Vegh, Organizers

Raoul Minetti, Michigan State University ,Maria Soledad Martinez Peria, The World Bank
Foreign Lenders in Emerging Economies

In recent decades, emerging economies have frequently experienced sustained output growth but also large volatility of output and asset (for example, real estate) prices after liberalizing their credit markets. Iacoviello and Minetti study an economy where firms face credit constraints tied to the pledgeable returns -- output and collateralizable assets -- on their investments, and where domestic and foreign lenders have different comparative advantages in obtaining investment returns. Building on evidence from emerging economies, the authors postulate that foreign lenders are more efficient than domestic ones in monitoring the output of specialized assets, but have less information in the local market where assets are traded. This analysis reveals that opening the economy pronounced the lower is the degree of contract enforceability in the foreign lenders can raise average productivity and output but also increase the volatility of output and the price of collateral assets over the business cycle. These effects appear more.

Thorsten Beck, Tilburg University and Maria Soledad Martinez Peria, The World Bank
Foreign Bank Participation and Outreach: Evidence from Mexico

Recently, developing countries have witnessed a sharp increase in foreign bank participation. Using newly gathered data for Mexico, where foreign bank participation rose from 2 percent to 83 percent of assets during 1997-2005, Beck and Peria examine the impact on banking outreach. Country-, bank-, and bank-municipality level estimates show a decline in the number of deposit and loan accounts. While country- and bank-level estimates indicate an increase in the share of municipalities with bank branches and in the likelihood of bank presence, the bank-municipality regressions show that only rich and urban municipalities benefited. Overall, the evidence is consistent with a decline in outreach.

Todd Gormley, Washington University in St. Louis
Costly Information, Foreign Entry, and Credit Access

Using a theoretical model that incorporates both foreign and domestic lenders in the presence of asymmetric information, Gormley analyzes how foreign entry affects access to credit. His model shows that foreign entry has the potential to create a segmented market in which foreign lenders specialize in financing a small subset of high-return firms. This segmentation increases credit access for those firms targeted by foreign lenders, but potentially reduces credit access for other firms, including those that rely solely on domestic lenders. The overall impact on credit access and net output will depend on the distribution of firms, the relative costs of lenders, and the cost of acquiring information about borrowers. This analysis provides new insights into the unexplained consequences of foreign entry into emerging markets.

Geert Bekaert, NBER and Columbia University; Campbell R. Harvey, NBER and Duke University; Christian T. Lundblad, University of North Carolina, Chapel Hill, and Stephan Siegel, Columbia University
What Segments Equity Markets?

Bekaert, Harvey, Lundblad, and Siegel propose a new, valuation-based measure of segmentation in the world equity market. Although segmentation in many developing countries has decreased, the level of segmentation is still significant. The authors characterize the factors that account for variation in market segmentation both through time and across countries. A country's regulation with respect to foreign capital flows is important in determining its level of segmentation, but non-regulatory factors are also related to the cross-sectional and time-series variation in the level of segmentation, they find. They identify a country's political risk profile and its stock market development as two additional local segmentation factors, along with the U.S. corporate credit spread as a global segmentation factor.

Sebnem Kalemli-Ozcan, NBER and University of Houston; Bent Sorensen, University of Houston, and Vadym Volosovych, Florida Atlantic University
Deep Financial Integration and Volatility

Kalemli-Ozcan, Sorensen, and Volosovych investigate the relationship between financial integration, firm-level volatility, and aggregate output fluctuations. They ask whether capital market integration is associated with increased or decreased volatility of firms, and whether firm-level volatility carries over to aggregate data. Using micro data, they construct a measure of “deep” financial integration based on direct observations of foreign ownership at the firm-level, measuring domestic financial development as the extent of cross-ownership within a region. The authors then aggregate up to regions within countries to examine the effect of financial integration on aggregated volatility. Next, they consider the effect of integration on the volatility of regional level GDP, finding that deep financial integration has a significant positive effect on the volatility of firms’ sales and employment. This effect survives aggregation and carries over to regional output. Interestingly, a higher level of domestic financial development has no effect on the volatility of regional output, nor do firms with more diversified domestic ownership structure display different levels of fluctuations.

Scott Davis, Vanderbilt University
The Effects of Globalization on International Business Cycle Co-Movement: Is All Trade and Finance Created Equal?

Davis tests for the effects of increased trade and financial integration on business cycle co-movement. He measures and explains the channels from bilateral trade integration, financial integration, and industrial specialization to international output co-movement. He also uses his model to measure the causal channels between trade, finance, and specialization. When Davis divides trade integration into trade of intermediate versus final goods, the data and his model both show that intermediate-goods trade has a greater effect on co-movement than final-goods trade. When he divides financial integration into credit market and capital market integration, the data predict that credit-market integration has a positive effect on output co-movement, but that capital-market integration has a negative effect. However, this presents a puzzle, because the model cannot replicate the positive effect of credit-market integration on output co-movement.

Uluc Aysun, University of Connecticut; and Adam Honig, Amherst College
Bankruptcy Costs, Liability Dollarization and Vulnerability to Sudden Stops

Emerging market countries that have improved their institutions and attained intermediate levels of institutional quality have experienced severe financial crises following capital-flow reversals. However, there is also evidence that countries with strong institutions and deep capital markets are less affected by external shocks. Aysun and Honig reconcile these two observations using a model that extends the financial accelerator framework developed in Bernanke, Gertler, and Gilchrist (1999). The model here captures financial market institutional quality with creditors’ ability to recover assets from bankrupt firms. Bankruptcy costs affect vulnerability to sudden stops directly, but also indirectly, by affecting the degree of liability dollarization. Simulations reveal an inverted U-shaped relationship between bankruptcy recovery rates and the output loss following sudden stops. The authors provide empirical evidence that this non-linear relationship indeed exists.

Filippo Brutti, Universitat Pompeu Fabra
Legal Enforcement, Public Supply of Liquidity and Sovereign Risk

Sovereign debt crises in emerging markets usually are associated with liquidity and banking crises within the economy. This connection is suggested by both anecdotal and empirical evidence. The conventional view is that the domestic financial turmoil is caused by foreign creditors' retaliation. Yet, there is no clear cut evidence supporting the existence of “classic” default penalties (for example, trade sanctions, or exclusion from international capital markets). Brutti proposes a novel mechanism linking sovereign defaults with liquidity and banking crises without any intervention on the part of foreign creditors. He considers a standard unwillingness-to-pay problem assuming that: 1) the enforcement of private contracts is limited and, as a result, public debt represents a source of liquidity; and 2) the government cannot discriminate between domestic and foreign agents. In this setting, the prospect of drying up the private sector's liquidity restores the ex-post incentive of the government to pay without any need to assume foreign penalties. Nonetheless, liquidity crises may arise when economic conditions deteriorate and the government opportunistically chooses to default in order to avoid repayment of foreign agents. Brutti then exploits the interaction between the enforcement friction and sovereign risk to study the implications for international capital flows and legal and institutional domestic reforms.

Laura Alfaro, Harvard University and NBER, and Andrew Charlton, London School of Economics
Intra-Industry Foreign Direct Investment

Alfaro and Charlton use a new firm-level dataset that establishes the location, ownership, and activity of 650,000 multinational subsidiaries. Using a combination of four-digit level information and input-output tables, the authors find that the share of vertical FDI (subsidiaries that provide inputs to their parent firms) is larger than commonly thought, even within developed countries. Most subsidiaries are not readily explained by comparative advantage considerations by which multinationals locate activities abroad to take advantage of factor-cost differences. Instead, multinationals tend to own the stages of production proximate to their final production, giving rise to a class of high-skill, intra-industry vertical FDI.

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