This project will focus on the determinants of international financial investment. Economic theory suggests that in a fully integrated world market with no frictions, investors will hold an identical portfolio of world assets motivated by risk sharing. However, despite financial globalisation, data shows that there is a ‘home bias’ effect whereby domestic investors seem to hold lower than predicted levels of foreign equities, and cross-border investment seems to be directed significantly to geographically closer economies.
Indeed, observed patterns of financial stocks and flows seem to fit a ‘gravity model’ with market size (often proxied by GDP) and the geographical distance between countries being important predictors. Projects will begin by briefly explaining the theory, before exploring why country size matters and unpack how geographical distance may be related to transaction costs and information asymmetries that influence patterns of asset trade.
The core of the project will involve estimating, using new data, a simplified version of the model in:
• Chiţu, Livia & Eichengreen, Barry & Mehl, Arnaud, 2014. “History, gravity and international finance,” Journal of International Money and Finance, Elsevier, vol. 46(C), pages 104-129.
This will involve data collection from online sources (U.S Portfolios of Foreign Securities & the historical Census of American-owned assets in Foreign Countries) and the estimation of this model using linear regression. Projects will then interpret their results in context of theory and previous literature. Good projects will be able to further explain the intuition behind the hypothesized ‘history effect’.