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The determinants of cross-border equity flows

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In this paper, the authors explore a new panel data set on bilateral gross cross-border equity flows between 14 countries, 1989-1996, and show that a "gravity" model explains international transactions in financial assets at least as well as goods trade transactions.
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This article is published in Journal of International Economics.The article was published on 2005-03-01 and is currently open access. It has received 1244 citations till now. The article focuses on the topics: Database transaction & Equity home bias puzzle.

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Gravity Equations: Workhorse,Toolkit, and Cookbook

TL;DR: In this article, the estimation and interpretation of gravity equations for bilateral trade is discussed, and several theory-consistent estimation methods are presented. But the authors argue against sole reliance on any one method and instead advocate a toolkit approach.
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Trying to Explain Home Bias in Equities and Consumption

TL;DR: In this paper, the authors discuss the potential relationship between consumption home bias and foreign equities and show that consumption growth rates tend to co-move across countries even when output growth rates do not.
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Cultural Biases in Economic Exchange

TL;DR: This paper used data on bilateral trust between European countries and found that lower bilateral trust leads to less trade between two countries, less portfolio investment, and less direct investment, even after controlling for the characteristics of the two countries.
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Business and Social Networks in International Trade

TL;DR: In this article, the role of transnational networks in alleviating problems of contract enforcement and providing information about trading opportunities is surveyed, and how domestic networks influence international trade through their impact on domestic market structure.
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Why Doesn't Capital Flow from Rich to Poor Countries? An Empirical Investigation

TL;DR: This paper examined the empirical role of difierent explanations for the lack of flow of capital from rich to poor countries, including differences in fundamentals across countries and capital market imperfections, and showed that during 1970-2000 low institutional quality is the leading explanation.
References
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Book

Econometric Analysis of Panel Data

TL;DR: In this article, the authors proposed a two-way error component regression model for estimating the likelihood of a particular item in a set of data points in a single-dimensional graph.
Journal ArticleDOI

Legal Determinants of External Finance

TL;DR: The authors showed that countries with poorer investor protections, measured by both the character of legal rules and the quality of law enforcement, have smaller and narrower capital markets than those with stronger investor protections.
Journal ArticleDOI

Home Bias at Home: Local Equity Preference in Domestic Portfolios

TL;DR: The authors showed that the strong bias in favor of domestic securities is a well-documented characteristic of international investment portfolios, yet the preference for investing close to home also applies to portfolios of domestic stocks.
Journal ArticleDOI

Domestic Saving and International Capital Flows

TL;DR: In this paper, the authors analyzed the international capital market and analyzed a wide range of issues including the nation's optimal rate of saving and the incidence of tax changes and found that saving that originates in a country remains 'to be invested there'.
Journal ArticleDOI

The Endogenity of the Optimum Currency Area Criteria

TL;DR: This paper investigated the relationship between international trade patterns and international business cycle correlations and found that countries with closer trade links tend to have more tightly correlated business cycles, while countries with weaker trade links tended to have weaker business cycles.
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Frequently Asked Questions (10)
Q1. What have the authors contributed in "Nber working paper series the determinants of cross- border equity flows" ?

The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research. 

Their results demonstrate that market size, openness, efficiency of transactions, and distance are the most important determinants of transaction flows. 

The two key elements that are required to generate such an equation are: 1) that assets are imperfect substitutes because they insure against different risks; 2) that cross-border asset trade entails some transaction or information costs. 

Frankel and Rose (1998) show that trade between country pairs is positively related to the correlation of their business cycles; since trade decreases with distance, business cycle correlation does as well. 

This is a common ‘home market effect’ in equations for trade in goods (large countries have high demand, more producers, produce to avoid transport costs, and export the surplus – see Feenstra, Markusen and Rose, 1998). 

The authors use ‘home bias’ in a very general sense, referring to the evidence that residents of a given country invest much less abroad than portfolio allocation models would appear to suggest as optimal diversification. 

To summarise, the estimating equation arising out of this analysis takes the following form:Log(TAB,t) = .1 log(mcapA,t) + .2 log(mcapB,t) + .3 log(distanceAB,t) + .4 information variables + .5 transaction technology variables + .6 cyclical variables + }AB,t10 

In fact, when the authors include explicit informational variables, as in the next sub-section, the authors discover that the coefficients on these financial centre dummies fall further in size and become very unstable (often taking negative signs) in individual annual cross-sections. 

An alternative argument for a gravity model of equity trade starts from the observed complementarity between trade and FDI flows. 

The overall goodness of fit of this equation rises dramatically too: from the initial R2 = 0.36 (Table1) to R2 = 0.60 (recall the authors have over 1400 degrees of freedom, with 182 crosssection observations for each of eight years).