Financial Integration and Growth in a Risky World

Abstract

We revisit the debate on the benefits of financial integration in a two-country neoclassical growth model with aggregate uncertainty. Our framework accounts simultaneously for gains from a more efficient capital allocation and gains from risk sharing—together with their interaction. In our general equilibrium model, risk sharing brought by financial integration has an effect on the steady-state itself, altering convergence gains from capital accumulation. Because we use global numerical methods, we are able to do meaningful welfare comparisons along the transition paths. Allowing for country asymmetries in terms of risk, capital scarcity and size, we find important differences in the effect of financial integration on output, direction of capital flows, consumption and welfare over time and across countries. This opens the door to a richer set of empirical implications than previously considered in the literature.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.