Financial Globalization, Portfolio Diversification, and the Pattern of International Trade

Abstract

The paper provides a general-equilibrium model where incomplete international financial markets lead to insufficient industrial specialization and low international trade. As international portfolio diversification is limited and productivity is uncertain, investors wish to maintain a diversified industrial structure rather than specializing according to their comparative advantage. Financial globalization then induces more specialization and more trade. The present framework yields explicit closed-form solutions for the volume and the structure of trade. Empirical results support the implications of the theory. Trade in financially open countries is (i) higher, (ii) more dependent on productivity differences, and (iii) less sensitive to industry risks.Markets;Economic models;international trade, financial markets, globalization, financial globalization, international financial, international financial markets, financial integration, volume of trade, trade barriers, trade flows, capital flows, trade volume, world output, trade structure, full liberalization, net exports, pattern of trade, pattern of specialization, trade costs, bilateral trade, multilateral trade, trade dependence, political economy, industry trade, trade patterns, world trade, equilibrium model, access to international financial markets, product differentiation, domestic consumption, closed economies, trade theory, closed economy, open economies, factor price, export industries, economic integration, global integration, trade model, comparative advantage index, net exporter, trade imbalances, trade volumes, factor endowments, foreign trade, metal products, foreign assets, liberal trade policies, trade data, regional trade, world prices, intermediate scenarios, forward market, trade openness, imperfect competition, elasticity of substitution, measure of trade, foreign asset, border trade, international standard, globalization process, factor price equalization, national borders, transport equipment, world market, asset market, trade policies, market integration, commodity prices, export performance, world industry, trade models, liberal trade, tariff rates