Financial Integration and the Correlation between International Debt and Equity Flows

Abstract

This paper empirically documents a number of stylized facts of international debt and equity flows and theoretically investigates the roles of these two financial assets in international risk sharing. Using a data set of debt and equity flows since 1970 for a sample of 104 countries, I find that international debt and equity flows have become increasingly volatile in the past decades due to the increased world financial integration. In addition, there is a negative correlation between debt and equity flows and such negative correlation has become stronger over time. Using a simple two-country model with international capital flows, I show that negatively correlated debt and equity flows arise as two countries trade equity assets and bond to hedge against income uncertainties. The numerical analysis shows that the model can replicate the dynamics of the volatilities and correlation between debt and equity flows in the data as the financial integration progresses.