5 The overall effects of global financial integration on the stability of the financial sector can be expected to be positive in the long run, because greater liquidity and the adoption of risk-sharing and riskmitigating techniques both strengthen the overall resilience and shock-absorption capacity of the global financial system. Cross-border capital flows not only benefit the recipient economies, but also the countries of origin, as they facilitate international risk-sharing and participation in returns abroad. Trade in goods and services and cross-border capital flows have clearly increased the spillovers of macroeconomic fluctuations globally. 6 However, one should welcome the recent developments in  5  For a comprehensive analysis on the determinants of global portfolio reallocation, see De Santis and Gérard (2006). 6  See Kose et al. (2003) for an assessment of the impact of globalisation on the synchronisation of business cycles.http://www.iza.org/en/webcontent/publications/papers/viewAbstract?dp_id=702. BIS Review 43/2006  3  international financial integration, because they reflect trends towards an efficient allocation of resources and, in this way, support growth and promote welfare in the global economy. How much further will financial globalisation deepen? In order to answer this question, we examine developments in countries’ home bias, i.e. how much investors prefer to invest in domestic assets rather than fully diversifying their portfolio internationally. 7 In a world without transaction and information costs, all countries would hold the same portfolio and would diversify their investment in other countries in proportion to the size of their financial markets.

Home bias in the debt instrument market euro area countries (annual data) among euro area countries (annual data)  Sources: IMF, Thomson Financial DataStream, Sources: BIS, IMF, ECB calculations. ECB calculations. Note: The home bias of the euro area is computed Note: The home bias of the euro area is computed excluding intra-euro area asset trade allocation. excluding intra-euro area asset trade allocation. Indeed, a simple inspection of the data reveals that European countries increased their holdings of euro area international assets (as a share of their total international portfolio) between 1997 and 2003 (see Charts 5-6). 10 Over this period, the share of intra-euro area allocation increased markedly by 10 percentage points for equity portfolios and by almost 25 percentage points for fixed income portfolios. 10  12 EMU countries consists of the 12 euro area countries. “Other EU countries” refers to Denmark, Sweden and the United Kingdom. “Non-EU developed countries” comprises ten other developed countries: Australia, Bermuda, Canada, Iceland, Israel, Japan, New Zealand, Norway, Singapore and the US. “Emerging markets” is formed by 7 countries: four Asian emerging markets (Indonesia, Korea, Malaysia and Thailand) and three Latin American emerging markets (Argentina, Chile and Venezuela). BIS Review 43/2006  5  Moreover, global financial integration was accompanied by a large shift in holdings towards the euro area countries, thereby favouring international risk-sharing vis-à-vis the euro area, particularly with regard to other European countries and, to a lower extent, with respect to emerging markets in equity portfolios (see Charts 5 and 6).