Financial super-markets: size matters for asset trade

Abstract

Empirically, demand and market size effects play an important role for international trade in assets and the determination of asset prices. Financial integration decreases the cost of capital, asset prices increase with investors base and market size determines international financial flows. We present a two-country model with an endogenous number of financial assets, where the interaction of a risk diversification motive and market segmentation explains those facts. In our set up, an imperfectly competitive structure of financial markets emerges naturally and provides a new source for home bias in equity holdings. Due to co-ordination failures, the extent of financial market incompleteness is inefficiently high in equilibrium.