Optimal financial-market integration and security design

Acharya, V and Bisin, A (2003) Optimal financial-market integration and security design. Working Paper. London Business School IFA Working Paper.

Abstract

We study twoperiod pureexchange Capital Asset Pricing Model (CAPM) economies, for given degrees of incompleteness of ficial markets and given degrees of restricted participation of agents in the markets. We characterise the optimal ficialmarket structure of this economy and effiicient ficial innovations that consist of both the introduction of new assets and the integration of segmented markets. We show that maximal advantage from the integration of ficial markets arises when fundamentals are minimally or negatively correlated. Our results have implications for the welfare gains associated with international ficial integratiod formation of currency areas. We also show that a coordination of ficial innovations, e.g., in the form of consolidation of exchanges, is likely to be socially desirable when asset markets are partially segmented.