Financial integration and the correlation between international debt and equity flows

This paper empirically documents a number of stylized facts about international debt and equity flows and theoretically investigates the roles of these two financial assets in international risk sharing. Using a dataset 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 recent decades due to the increased world financial integration. In addition, there is a negative correlation between the debt and equity flows, and this negative correlation has become stronger over time. Using a simple two-country model with international capital flows, I show that a negative correlation between the debt and equity flows arises when two countries trade equity assets and a bond to hedge against income uncertainties. The numerical analysis shows that the model can replicate the dynamics of the volatilities and correlation between the debt and equity flows in the data as financial integration progresses.