The determinants of cross-border equity flows

Abstract

We explore a new panel data set on bilateral gross cross-border equity flows between 14 countries, 1989–1996. We show that a “gravity” model explains international transactions in financial assets at least as well as goods trade transactions. Gross transaction flows depend on market size in source and destination country as well as trading costs, in which both information and the transaction technology play a role. Distance proxies some information costs, and other variables explicitly represent information transmission, an information asymmetry between domestic and foreign investors, and the efficiency of transactions. The geography of information is the main determinant of the pattern of international transactions, while there is weak support in our data for the diversification motive, once we control for the informational friction. We broaden the scope of our results by presenting some evidence linking the results on equity transactions to equity holdings.