March 2024
Sunil Sharma (George Washington University)
Abstract: The paper investigates the long-run output effects of international financial integration, and in particular their dependence on a country’s institutions as proxied by the quality of governance and the level of domestic financial market development. The econometric framework takes account of heterogeneous short- and long-run dynamics, state-dependent thresholds for governance quality and financial development, cross-sectional dependence, output levels and growth rates, and the potential endogeneity of international financial integration. New indices capturing multiple dimensions of governance quality and domestic financial markets are used. Using a sample of 49 relatively large advanced and emerging market economies over the period 1971-2015, the empirical results suggest that a country’s output benefits from international financial integration if it has sufficiently good governance and a reasonably developed domestic financial system; and above the thresholds such benefits generally increase with measures of good governance and the development of the domestic financial system. Output gains from international financial integration are estimated to be modest, especially for less developed countries.
