The Euro effect in international asset holdings

1. The Euro effect in international asset holdings Barbara Pels Trinity College Dublin Institute of International Integration Studies

2. Creation of Eurozone • Removes currency risk for within Euro zone asset trade • Creates a more unified financial structure within Eurozone (especially for bonds) => Reduction in information costs and transaction costs for asset trade with(in) Eurozone

3. Research Questions • Do Eurozone countries invest proportionally more in other Eurozone countries? • Do non Eurozone countries invest proportionally more in Eurozone?

4. Do Eurozone countries invest proportionally more in other Eurozone countries? Previous literature: • Lane and Milesi-Ferretti (2004) • Lane (2006) • Aviat and Coeurdacier (2007) • Coeurdacier and Martin (2007)

5. Gravity framework • Well known from trade literature • Derivation of gravity equation from theoretical model of asset trade: Portes & Rey (2005) Lane & Milesi-Ferretti (2004) Aviat & Coeurdacier (2007) Martin & Coeurdacier (2007) log(Asset)ij = c + log(sizeisizej) + log(transaction costs)ij i: source country j: destination country

6. Compare cross-section over time (2001-2006) log(F)ij = αi + αj + δEMUij + θXij + εij Fij Bilateral asset holdings (bond/equity) CPIS Xij log(Imports) IMF – Direction of Trade Statistics Distance CEPII EU15 Common coloniser CEPII Common official language CEPII Colonial relationship CEPII Contiguous CEPII

7. Sample CPIS: Number of source countries: 67 Number of host countries/territories: 220 Time span: 2001-2006 40 offshore centres removed from sample • 48 source countries • 167 host countries

8. Econometric issues • Bilateral asset holdings: many zero values/ (almost) no negative values • Common approaches • Add a constant to the bilateral asset holding log(F+1)ij • Limit sample to non zero observations • Tobit regression (censored regression) • Poisson Quasi Maximum Likelihood

9. Bonds: OLS (asset + 1)

10. Equity: OLS (asset + 1)

15. Euro effect: countries in Eurozone invest disproportionally in other Eurozone countries • Is this due to the existence of the European monetary union, or due to other characteristics of Eurozone countries? • Test this by assessing 1997 data

16. Comparison with pre-Euro period

17. Euro effect Reduction in transaction costs for intra-Euro area asset trade • Due to elimination of exchange rate risk? • Due to harmonisation of financial structure in the Eurozone?

20. Euro effect on outsiders log(F)ij = αi + αj + δ1EMUij + δ2EMEMUij + δ3EUREMUij + δ4ADVEMUij + δ5RWEMUij + θXij + εij EMEMU Emerging markets EUREMU Wider Europe ADVEMU Advanced economies RWEMU ‘Rest of world’

23. Conclusion • Euro effect for insiders • First evidence that Euro bias in asset holding is due to a one-off change in investment behaviour • Effect stronger for bonds than for equity • Euro effect cannot be explained by the elimination of exchange rate risk in Eurozone • Euro effect for outsiders • First indication that Euro effect also affects countries that are not Euro area members • Effect stronger for equity

24. Thank you

28. Comparison other research