Multicountry empirical investigation into international financial integration

This paper focuses on the dynamics of international financial integration for a set of 13 industrial countries1 including Australia over the period 1990 to 2003 by analysing data on the level and composition of foreign assets and liabilities. The objective of the study is to provide insights into the broad trends on cross country holdings of FDI and portfolio equity. An analysis of the composition of countries holdings of foreign assets and liabilities is important in that a particular combination of cross holdings can reduce the volatility of countries national income by generating investment income streams that are imperfectly correlated with domestic output fluctuations. The study investigates the correlation of international asset positions with various ‘explanatory variables’ such as the degree financial restrictions, the depth of the financial market, the openness to international trade, etc. The paper then examines returns on various asset classes (debt, portfolio equity, and FDI) in an attempt to measure from the returns the degree of diversification that is being offered by international investments. The results show that the growth in goods trade and stock market capitalisation are the main determinants of the growth in the scale of international balance sheets. In our analysis of rates of return on foreign assets and liabilities we find that international cross holdings provide diversification against fluctuations in domestic market returns.