What is the relationship of international trade and financial integration? Both trade openness and financial integration have been increasing steadily over the last few decades; there is also some evidence suggesting that the two go hand-in-hand (Lane and Milesi-Ferretti (2008)). However it has been difficult to empirically establish a causal relationship between the two. The exit of the United Kingdom from the European Union presents a natural experiment for analysing the causal effects of changes in country trade relationships on financial integration. We propose to study this link by taking advantage of a very rich database of the Euro system, namely the Securities and Holdings Statistics which keeps a very granular record of security holdings within the Euro area in the past ten years. Combining this dataset with trade and firm data from the United Kingdom and European Union, we will study how the exogenous shock of severing trade relations between the two economies has affected the portfolio holdings of European investors. Our analysis will be both qualitative and quantitative: first by establishing whether there is a causal relationship between trade and financial integration, and second by measuring the size and persistence (or lack of thereof ) of the effects of the Brexit shock on asset portfolio holdings.

The proposed project is closely linked to the objective of the Keynes Fund to enhance understanding of market (in)efficiencies. We will study the effects of government policy barriers to international trade, which naturally introduce inefficiencies into markets, on the portfolio holdings of international asset market participants. The UK’s exit from the EU introduced new fixed and variable costs of economic activity around cross-border financial transactions, which disrupted previously well functioning markets and potentially forced European investors to re-balance their international portfolio holdings. As a consequence, such changes to asset market functioning or corporate structures may have more broadly triggered a substantial cross-border reallocation of capital. Our research will improve the understanding of these phenomena and is of interest for several fields in economics, including trade economics, international finance, portfolio analysis, behavioral finance, as well as for policy makers who are interested in the consequences and impacts of major trade policy changes on international financial markets.