This paper provides an analysis of the impact of international portfolio flows on security returns. It concludes that opening a country to portfolio flows decreases its cost of capital without adverse effects on its securities markets. There is no convincing evidence that portfolio flows increase the volatility of equity returns or lead to excessive comovement of a country's equity returns with world equity returns. Though there has been much concern that portfolio flows create contagion effects, existing empirical evidence does not provide conclusive evidence that contagion due to uninformed investors is economically important. See Feldstein and Horioka (1980). 1 The 1996 numbers are obtained from World Bank (1997). 2 1 For most of the period following World War II, the economic significance of net capital flows wa s small. Further, net portfolio flows were even l ess important. Over recent years, net capital flows have become 1 much larger, especially towards developing econom...

Motivated by the behavior of asset prices, trading volume and price volatility during historical episodes of asset price bubbles, we present a continuous time equilibrium model where overconfidence generates disagreements among agents regarding asset fundamentals. With short-sale constraints, an asset owner has an option to sell the asset to other overconfident agents when they have more optimistic beliefs. As in Harrison and Kreps (1978), this re-sale option has a recursive structure, that is, a buyer of the asset gets the option to resell it. Agents pay prices that exceed their own valuation of future dividends because they believe that in the future they will find a buyer willing to pay even more. This causes a significant bubble component in asset prices even when small differences of beliefs are sufficient to generate a trade. In equilibrium, large bubbles are accompanied by large trading volume and high price volatility. Our model has an explicit solution, which allows for several comparative statics exercises. Our analysis shows that while Tobin’s tax can substantially reduce speculative trading when transaction costs are small, it has only a limited impact on the size of the bubble or on price volatility. We also give an example where the price of a subsidiary is larger than its parent firm. This paper was previously circulated under the title “Overconfidence, Short-Sale Constraints and Bubbles.”

Abstract not found

Completely flexible exchange rates may be “excessively ” volatile, with the implied currency misalignments leading to real inefficiencies in resource allocation and detrimental effects on economic growth. This paper analyses whether international currency taxation would be effective in calming exchange rate volatility and avoiding currency crises within the context of a simple model of exchange rate determination. It is found that the effects of a tax on foreign exchange volatility depend on the nature of speculation and whether the focus is on capital inflows or outflows. Key words: foreign exchange, IMF, capital flows, Tobin tax, volatility

The main conclusions of the paper are the following: CIn order to minimize switching costs, the name of the new EU currency should be the D-mark. CDifferential national requirements for seigniorage revenue provide a weak case for retaining national monetary independence. CFrom the point of view of adjustment to asymmetric shocks, nominal exchange rate flexibility is at best a limited blessing and at worst a limited curse. CInter-state labour mobility in the USA does not compensate for the absence of state-level exchange rate flexibility. CThe absence of significant inter-member fiscal redistribution mechanisms in the EU is not an obstacle to monetary union. CConvergence or divergence in real economic performance is irrelevant for monetary union. CA common currency is the logical implication of unrestricted

This paper explores the increasing the heterogeneity of an agent population to stabilize decentralized systems by adding bias terms to each agent’s expected payoffs. Two approaches are evaluated, corresponding to heterogeneous preferences and heterogeneous transaction costs; empirically, the transaction cost case provides stability with near optimal payoffs under certain conditions. Theoretically, in the idealized case of an infinite number of agents, it is proven that the system with added heterogeneous preferences has a fixed point different from that of the unbiased system, guaranteeing suboptimal performance, while the transaction cost case is demonstrated to have a fixed point identical to that of the unbiased system, and it is further shown to be a contraction mapping, guaranteeing convergence. This contraction mapping allows us to conceptualize the model with heterogeneous transaction costs as a decentralized root finding system. Topic areas: decentralized systems, distributed search 1

Motivated by the behavior of internet stock prices in 1998-2000, we present a continuous time equilibrium model of bubbles where overconfidence generates agreements to disagree among agents about asset fundamentals. With a short-sale constraint, an asset owner has an option to sell the asset to other agents when they have more optimistic beliefs. This re-sale option has a recursive structure, that is a buyer of the asset gets the option to resell it, causing a significant bubble component in asset prices even when small differences of beliefs are sufficient to generate a trade. The model generates prices that are above fundamentals, excessive trading, and excess volatility. We also give an example where the price of a subsidiary is larger than its parent firm. Our analysis shows that while Tobin's tax can substantially reduce speculative trading when transaction costs are small, it has only a limited impact on the size of the bubble or on price volatility.

heir saving by investing in the emerging market than they could domestically. Third, everyone benefits from the opportunity to diversify away risks and smooth disturbances. Fourth, letting foreign financial institutions into the country improves the efficiency of domestic financial markets. Over-regulated and potentially inefficient domestic institutions are subject to the harsh discipline of competition and the demonstration effect of having examples to emulate. At the same time, the governments face the discipline of the international capital markets in the event they make policy mistakes (e.g., in their domestic regulatory duties). There are some indications, however, that financial markets do not always work quite as perfectly as the happy view of the economic theorist suggests. Most salient are such recurrent disruptions as the 1982 international debt crisis, 1992-93 crisis in the European Exchange Rate Mechanism, 1994-95 Mexican peso crisis, and 1997-98 Asian financial crisis

thank Mark Peralta for research assistance and to seminar participants at EPRU

A number of economists have supported the taxation of speculation in financial markets. We examine the welfare economics of such a tax in a model of a financial market where some agents have superior information and others have a hedging motive. We show that a tax on speculators may actually increase speculative profits. This occurs if the speculators' benefit from less informative prices offsets the cost of the tax. The effect on the welfare of other agents depends on how information revelation changes risk-sharing opportunities. It is possible for the introduction of a tax to cause a Pareto improvement.