We explore a new panel data set on bilateral gross cross-border equity flows between 14 countries, 1989-96. We show that a “gravity ” model explains international transactions in financial assets at least as well as goods trade transactions. Gross transaction flows depend on market size in both source and destination country as well as trading costs, in which both information and the transaction technology play a role. Distance proxies some information costs, and other variables explicitly represent information transmission, an information asymmetry between domestic and foreign investors, and the efficiency of transactions. The remarkably good results have strong implications for theories of asset trade. We find that the geography of information is the main determinant of the pattern of international transactions, while there is weak support in our data for the diversification motive, once we control for the informational friction. We strengthen our conclusions by investigating- in another data set- the ability of our information variables to explain transactions in classes of assets with different informational content (corporate bonds, equities and government bonds). Finally, we broaden the scope of our results by presenting some evidence linking the results on equity transactions to equity holdings.

We review the international finance literature to assess the extent to which international factors affect financial asset demands and prices. International asset pricing models with mean-variance investors predict that an asset’s risk premium depends on its covariance with the world market portfolio and, possibly, with exchange rate changes. The existing empirical evidence shows that a country’s risk premium depends on its covariance with the world market portfolio and that there is some evidence that exchange rate risk affects expected returns. However, the theoretical asset pricing literature relying on mean-variance optimizing investors fails in explaining the portfolio holdings of investors, equity flows, and the time-varying properties of correlations across countries. The home bias has the effect of increasing local influences on asset prices, while equity flows and cross-country correlations increase

this paper we assess the claim that capital markets failed to perform their primary duties during the 1990s. Our assessment is grounded in a quantitative and qualitative analysis of local Asian capital markets and the interaction of Asian corporations with international capital markets. Where possible we compare the capital market performance and corporate performance within East Asia to that of Latin America. Our results indicate that a significant proportion of the growth in market capitalization of Asian markets during the 1990s resulted from the mobilization of new capital. Asian capital markets and international capital markets provided the funds required to sustain the high investment rates that characterized the region. Furthermore, Asian capital markets provided investors with the liquidity commonly associated with developed capital markets. During the 1990s, Asian capital markets also attempted to integrate themselves further into international capital markets. Financial market integration is arguably the most challenging issue that emerging markets face as they evolve into developed capital markets. We find that Asian governments pursued similar policies of gradual capital market reform including capital market liberalization during the 1990s. As a result of this process, foreign investors were able to participate directly in local equity markets. We show that foreign investors had a negligible impact on local stock market returns and volatility. Despite their significant growth, new capital mobilization, and attempts at financial market liberalization, Asian stock markets remained heavily concentrated in terms of market capitalization of individual firms and industry base. Financial firms and manufacturing firms dominated market indexes accounting for a minim...

This paper is based on a presentation made to the conference on Valuation in Emerging Markets at University of Virginia, May 28-30, 2002. We have benefited from discussions with and the comments of Chris Lundblad and Bob Brunner. *Corresponding author. E-mail address: cam.harvey@duke.edu

Much of the current debate on reforming the international financial architecture is aimed at reducing the risks of contagion—best defined as a significant increase in cross-market linkages after a shock to an individual country (or group of countries). This definition highlights the importance of other links through which shocks are normally transmitted, including trade and finance. During times of crisis, the ways in which shocks are transmitted do seem to differ, and these differences appear to be important. Empirical work has helped to identify the types of links and other macroeconomic conditions that can make a country vulnerable to contagion during crisis periods, although less is known about the importance of microeconomic considerations and institutional factors in propagating shocks. Empirical research has helped to identify those countries that are at risk of contagion as well as some, albeit quite general, policy interventions that can reduce risks.

... were allowed to float against other currencies, meaning that the currency was not formally pegged to some other currency or basket of currencies. This was up from 38 ten years earlier, suggesting a significant move toward greater flexibility of exchange rates. Yet during the 1990s half a dozen countries installed currency boards, a particular strong form of exchange rate fixity; ten European currencies were eliminated in favor of a common currency, the euro; other countries were actively considering installing currency boards, or even adopting the US dollar for domestic use. After a quarter century of floating among the major currencies, exchange rate policy is still source of vexation, and the appropriate choice is by no means clear. Should a country allow its currency to float, subject perhaps to exchange market intervention from time to time? Or should it fix its currency to

This paper discusses the benefits and risks that financial globalization entails for developing countries. Financial globalization can lead to large benefits, particularly to the development of the financial system. But financial globalization can also come with crises and contagion. The net effect of financial globalization is likely positive in the long run, with risks being more prevalent right after countries liberalize. So far, only some countries, sectors, and firms have taken advantage of globalization. As financial systems turn global, governments lose policy instruments, so there is an increasing scope for some form of international financial policy cooperation.

The 1997-98 financial crises in Asia and elsewhere have brought to the foreground the concern about offshore investment funds and their possible role in exacerbating financial market volatility. Offshore investment funds are alleged to engage in trading behaviors that are different from their onshore counterparts. Because they are less moderated by tax consequences, and are subject to less supervision and regulation, the offshore funds may trade more frequently. They could also engage more aggressively in certain trading patterns such as positive feedback trading or herding that could contribute to greater market volatility. Using a unique data set, we compare the trading behavior in Korea by offshore funds with that of three sets of onshore funds as control groups. There are a number of interesting findings. First, the offshore funds do trade more frequently than their onshore counterparts. Second, however, the offshore funds do not engage in positive feedback trading in a significant way. In contrast, there is strong evidence that the onshore funds from the U.S. and U.K. do. Third, while offshore funds herd, they do so significantly less than the onshore funds during the crisis. In sum, the offshore funds are not especially worrisome monsters relative to the onshore funds.

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This paper provides an overview of the recent theoretical and empirical research on herd behavior in financial markets. It looks at what precisely is meant by herding, the causes of herd behavior, the success of existing studies in identifying the phenomenon, and the effect that herding has on financial markets.