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The Role of Geography in Financial Integration: Foreign Direct Investment

The objective of this paper is to examine the role of geography in explaining the patterns of financial integration among both developed and developing countries. We investigate the determinants of North-North, North-South and South-North bilateral FDI inflows using a modified gravity model. The fact that the significance of geographical variables on FDI still remained even after controlling for the macroeconomic fundamentals, is in contrast with the standard capital market model. The results can, however, be reconciled if geographical factors can proxy for information costs, which may in turn explain why country portfolios are still home-biased.