Complementarity among international asset holdings

By utilizing a unique dataset and employing a variant of gravity models, we find strong evidence for the presence of complementarities among bank loans, short- and long-term debts, and portfolio equity holdings. The complementarities can be partially explained by common factors of standard gravity models such as economy size, state of economic development, and information cost proxies (such as distance), as well as bilateral trade in goods. However, we find an additional direct channel of complementarities among financial asset holdings that cannot be explained by these gravity factors. The complementarities are also robust to the consideration of unobserved fixed effects of both source and destination countries. We find evidence that the sequential reinforcing impact of bank lending on portfolio asset holdings is greater than the impact of portfolio asset holdings on bank lending. We also find that bank loans lead to subsequent portfolio asset holdings by partially alleviating information frictions. However, the role of portfolio investment seems to be independent from the information channel. The mutual reinforcement effect among cross-border asset holdings is stronger in destination countries with better quality of institutions. Overall our findings suggest that, while there may exist pecking order of cross-border investment due to differing sensitivity of capital flows to various costs and frictions, once a country receives a form of cross-border investment, this tends to induce other forms of investment and thus a deeper and more balanced financial integration. J. Japanese Int. Economies 23 (1) (2009) 37-55.