The Integration of Imperfect Financial Markets: Implications for Business Cycle Volatility

During the last two decades, the degree of openness of national financial systems has increased substantially. At the same time, asymmetries in information and other financial market frictions have remain prevalent. We study both empirically and theoretically the implications of the opening up of national financial systems in the presence of financial market frictions for business cycle volatility. In our empirical analysis, we demonstrate that stylised facts suggest that countries with more developed financial systems have lower business cycle volatility. Financial openness has no strong impact on business cycle volatility, in contrast. In our theoretical analysis, we use a dynamic general equilibrium model to study the implications of the opening up of national financial markets and of financial market frictions for business cycle volatility. We find that the implications of opening up national financial markets for business cycle volatility are largely unaffected by the presence of financial market frictions.