Masahiro Kawai

Eswar Prasad

" A Brookings Institution Press and Asian Development Bank Institute publication The global financial crisis has led to a sweeping reevaluation of financial market regulation and macroeconomic policies. Emerging markets need to balance the goals of financial development and broader financial inclusion with the imperative of strengthening macroeconomic and financial stability. The third in a series on emerging markets, New Paradigms for Financial Regulation develops new analytical frameworks and provides policy prescriptions for how the frameworks should be adapted to a world of more free and more volatile capital. This volume provides an overview of the global regulatory landscape from the perspective of Asian emerging markets. The contributors discuss the many challenges ahead in developing sound and flexible financial regulatory systems for emerging market economies. The challenges are heightened by the rising integration of these economies into global trade and finance, the growing sophistication of their financial systems as globalization and emergence processes accelerate, and their potential vulnerability to instability arising from the financial markets in the advanced economies. The contributors provide guidance about pitfalls to be avoided, general principles that should guide the creation of sound regulatory systems, and valuable analytic perspectives about how to continue to broaden the financial sector and innovate while still maintaining financial and macroeconomic stability. "

Emerging Market Perspectives

New Paradigms for Financial Regulation

G. Andrew Karolyi

David Tat-Chee Ng

We examine how emerging market (EM) investors allocate their stock portfolios internationally. Using both country-level and institution-level data, we find that the coming wave of EM investors systematically over- and under-weight their holdings in some target countries. These abnormal foreign allocation biases of EM investors offer robust support of the information endowment hypothesis of van Nieuwerburgh and Veldkamp (2009). Specifically, past capital and trade flows from a foreign country to the home country create an information endowment (or advantage) that lead home country investments to be overweight that foreign country. At the institutional level, information advantage proxies based on relationships between EM institutional investors and the headquarters of their parent companies have strong explanatory power for international portfolio allocations. The results remain robust after controlling for other factors like geographic and other measures of economic proximity, economic and capital market development, market integration, market returns and correlation, and corporate governance. The information advantage effect is stronger for EM investors for which external portfolios exhibit a higher degree of concentration.

Eswar Prasad

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