This project deals with "distance" as a key variable in international trade models, but does so in at least two innovative ways, by extending the meaning and bearing of "distance" to encompass several key distance related variables, which are often neglected in current contributions to the literature.
On the one hand, we build a model for the analysis of financial flows from advanced to emerging economies and reformulate the issue of transaction costs (Martin-Rey, 2004) in terms of a problem of trade in assets with different quality. The focus will be on countries' economic distance, as reflected in characteristics such as institutional development, regulation of markets, enforceability of laws and political risk. We will further consider the spillover effects from the country of origin to the country of destination, building on the idea that quality matters, with different intensity. We will thus model "perceived" quality as depending on investors¿ financial stress condition, and try to show that, besides the typical size effect, higher quality leads to higher asset demand and asset prices, and changes in "perceived" economic distance impact on the evolution of financial flows. We will run econometric estimations for cross-border bank flows from advanced to emerging economies for the period 2005-2014 and analyze the interaction of market segmentation and global spillover effects in determining the changes over time.
The other avenue we explore is that of modelling informational and other types of fixed costs to trade in a network related fashion. By generalizing some results in Chaney (2014) to a large bilateral dataset, albeit at a more aggregate level (two digit sector classification), we intend to show that geographic distance is relevant in explaining bilateral trade in goods and services, but "adjusted" distance, i.e. distance which accounts for the possibility of "remote" search by firms may be even more relevant in shaping the geography of trade flows.
We aim at contributing to the literature by providing a theoretical framework that can encompass the following key drivers of international asset trade: size effects, host country conditions, spillovers from the global instability or country of origin. Some authors use a gravitational model to account for size and distance, augmented by explanatory variables for the global stress conditions, the lender and borrower characteristics (Herrmann-Mihaljek, 2013). Our contribution is in deriving analytically the asset demand functions, and formalizing a novel concept of economic distance.
We introduce two innovations:
- we reinterpret transaction costs in terms of a problem of trade in assets with different quality, referring to the regulatory quality index developed in Papaioannou (2009).
- we introduce the idea that what matters in asset trade is quality as perceived by investors, on the basis of their liquidity-stress condition.
Our research allows to address several issues raised in the literature: the effect of country-specific bank regulatory policies or unconventional monetary policies aimed at supporting domestic lending in the country of origin, that impact on the investors' sensitivity to the quality index; the differentiated spillover effects to the recipient countries due to specific regulatory policies.
As for the second research question, the adoption of a much wider dataset will allow us to get new and interesting results, with respect to those already present in the literature. In particular, we will be able to check the pioneering results in Chaney (2014), and to highlight new channels whereby sequential access to markets might emerge. In particular, we wish to analyze the impact that the strenght of indirect connections exterts on bilateral trades, and the relative importance of network adjusted distances.
We plan to use a very detailed bilateral dataset, including trade from 155 exporters to 154 importers, accounting for about 98% of the whole world trade. The construcion of our dataset, however, will be complex, as we'll need to add, to the positive trade flows, zero trade flows for every combination of exporter, importer and sector, as we need a table of presence/absence of trade to run our probit estimations. In addition to the data on trade flows, we will have geographical and traditional gravity variables, as the population weighted distance, contiguity, regional trade agreement, etc.
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