Optimal financial-market integration and security design

Finance, Finance

IFA Working Paper

Acharya V;Bisin A

2003

We study two-period pure-exchange Capital Asset Pricing Model (CAPM) economies, for given degrees of incompleteness of financial markets and given degrees of restricted participation of agents in the markets. We characterise the optimal financial-market structure of this economy and effiicient financial innovations that consist of both the introduction of new assets and the integration of segmented markets. We show that maximal advantage from the integration of financial markets arises when fundamentals are minimally or negatively correlated. Our results have implications for the welfare gains associated with international financial integrationand formation of currency areas. We also show that a coordination of financial innovations, e.g., in the form of consolidation of exchanges, is likely to be socially desirable when asset markets are partially segmented.

Institute of Finance and Accounting, Institute of Finance and Accounting

FIN 374

IFA Working Paper

No