Asset prices in segmented and integrated markets
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Asset prices in segmented and integrated markets Paolo Guasoni1 · Kwok Chuen Wong1
Received: 24 April 2019 / Accepted: 9 April 2020 © Springer-Verlag GmbH Germany, part of Springer Nature 2020
Abstract This paper evaluates the effect of market integration on prices and welfare, in a model where two Lucas trees grow in separate regions with similar investors. We find equilibrium asset price dynamics and welfare both in segmentation, when each region holds its own asset and consumes its dividend, and in integration, when both regions trade both assets and consume both dividends. Integration always increases welfare. Asset prices may increase or decrease, depending on the time of integration, but decrease on average. Cross-asset correlation is zero or negative before integration, but significantly positive afterwards, explaining some effects commonly associated with financialisation. Keywords Asset pricing · Integration · Financialisation · Equilibrium Mathematics Subject Classification (2010) 91G10 · 91G80 JEL Classification G11 · G12 · G15
1 Introduction When investors gain access to a new asset class, diversification benefits loom large. Past price observations, from an era when the new asset class was unavailable to the P. Guasoni is partially supported by the ERC (279582), NSF (DMS-1412529), and SFI (16/IA/4443 and 16/SPP/3347).
B P. Guasoni
[email protected] K.C. Wong [email protected]
1
Dublin City University, School of Mathematical Sciences, Glasnevin, Dublin 9, Ireland
P. Guasoni, K.C. Wong
new investors, suggest both significant risk premia and modest correlations with existing asset classes. Yet, as the new investors adjust their portfolios, they find that correlations have increased, largely reducing the putative diversification gains. International equities (Solnik et al. [43], Goetzmann et al. [27]), emerging markets (Bekaert and Harvey [6]), and commodity futures (Tang and Xiong [46]) offer recent examples of this phenomenon. More broadly, the central problem is to understand how the integration of two markets affects the welfare of their participants, how such benefits – if any – are shared, and how integration changes the levels and dynamics of prices. To answer these questions, it is necessary to understand markets’ equilibria both in the regime of segmentation, when each market’s assets are available only to that market’s investors, and in integration, when any investor can trade any asset. This paper examines a general equilibrium model with two regions, each of them endowed with its own asset, and finds explicitly the two assets’ dynamics and their implied welfare in both the segmentation and integration regimes. It also identifies the terms of sharing under which investors in both markets would agree to integration. Similar to the familiar Lucas Jr. [32] tree, both regions have infinitely-lived representative investors with the same isoelastic preferences. Outputs in the two regions have uncorrelated short-term fluctuations, but remain cointegrated, their shares oscillating aroun
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