Abstract
Capital outflows after financial integration can lead to simultaneous increases in the national savings rate and asset prices of an economy with substantial financing costs. Under autarky, firms invest in risky capital while facing a borrowing constraint that creates a need for precautionary savings. Financial integration provides firms with access to foreign risk-free assets and results in two effects: a substitution effect, whereby firms divert some investments to foreign assets and cause capital outflows; and a wealth effect, whereby they grow richer in equilibrium and thus demand more domestic capital. Savings gluts and asset price booms occur when the wealth effect dominates.
Appendix
A. Proofs
In this Appendix we first detail the system of equations that characterize land price P and firm's portfolio choice α.
Financial Integration: in this equilibrium, firms choose optimal portfolio according to
Firms' net worth follows a geometric Brownian motion:
Define
Combining (14) and (15) into firm's value function yields
The solution is
For the refinancing boundary
W
, substituting
and
Together, one can solve for
Notice that
Define
The geometric Brownian motion
Finally, P I is the solution to the market clearing condition
where
Combining Equations (14 –16) and (18) solves for
Autarky: in this equilibrium, firms invest all their net worth in land. Therefore,
Therefore,
The dynamics of firm net worth follow another geometric Brownian motion:
There is a stationary distribution for W t , and its density function is given by (17). The density function implies the aggregate net worth E(W), which pins down P A from the solution to the market clearing condition:
Combining Equations (19–21) solves for P A .
Proof of Lemma 1. Take (16) as a function of β. The function has one negative root and one positive root. The left hand side is smaller than 0 when
For the autarky equilibrium, notice that
Proof of Proposition 1. To show the relationship between P
I
and P
A
, we start by showing that P
A
coincides with the solution of P
I
when
Equation (15) implies the geometric Brownian motion of firm net worth W
t
satisfies
Notice that from (16),
Define the left hand side of this equation as
Lemma A1.
Proof: Let
Now comparing P
I
and P
A
is equal to comparing the different solutions of
Lemma A2.
Proof: By the chain rule,
Lemma A3.
Proof: from
Taking logarithms on both sides of the equation gives
Differentiating this equation with respect to β yields
where
and
There are three parts to characterizing the derivative of α on β: Part A measures the change of payment boundary
Notice that part A is bounded by
Part A reaches this upper bound, defined as
First,
In every step above, the left hand side is made larger and right hand side made smaller and
Combining Lemmas A2 and A3 implies
Proposition 1 implies the following corollary.
Corollary 1:
Proof: From (16), β is an increasing function in λ. λ is a decreasing function in P. Therefore given
Proof of Proposition 2:
Proof: by the definition of savings rate,
and
Suppose
That is,
Dividing both sides by
First,
or
Therefore,
The left hand side has a minimum
When condition (23) is violated,
Proof of Proposition 3. The firm's value function solves
subject to the market clearing condition
The market clearing condition implies
The first two terms are the first order derivative of V with respect to α taking P as a constant. Setting them equal to zero gives
Let
Notice that,
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