Financial Integration, Growth and Volatility

Abstract

The aim of this paper is to evaluate the welfare gains from financial integration for developing and emerging market economies. To do so, we build a stochastic endogenous growth model for a small open economy that can: (i) borrow from the rest of the world; (ii) invest in foreign assets; and (iii) receive foreign direct investment. The model is calibrated on 46 emerging market and developing economies for which we evaluate the upper bound for the welfare gain from financial integration. For plausible values of preference parameters and actual levels of financial integration, the mean welfare gain from financial integration is around 13.5% of initial wealth. Compared with financial autarky, actual levels of financial integration translate into higher annual growth rates.