Similarly, in 2005 euro area residents held foreign portfolio holdings with a total value of approximately 3.5 trillion euro, a figure that is almost half of euro area’s annual GDP. Cross-border financial linkages, new financial products and the possibility of more accurate and wider risk-sharing have however also raised the level of interrelations across national financial markets. This implies that financial systems are more exposed to common risks, as financial disturbances may be transmitted more easily across borders in periods of turbulence. As a result, sceptics have indeed expressed concerns about the sustainability of global financial integration, which is regarded by some as having the potential to destabilise the global economy. But there is also an opposing view according to which global financial integration reduces the risks to the global economy, for which there are convincing arguments. In this respect, empirical evidence suggests that the strongest determinants of the global portfolio reallocation over the 1997-2001 period were (1) the need to diversify the risks of holding foreign portfolio assets across several countries, and (2) the willingness to close the gap between actual and optimal shares of foreign investment, which suggests that rational portfolio optimisation was the primary motivation behind investors’ reallocation of their international portfolios. This has two main implications: first, that investors do not ignore the main principles of portfolio theory; and second, that portfolio investments might be less prone to boom and bust cycles, being driven by long-term economic fundamentals.
Had the APF done so, in addition to strong primary market private sector demand, it would undoubtedly have helped to drive down market spreads. But it would also have risked displacing that private sector demand, to little purpose in my view. In fact, a greater intervention in this market during this period could have made things worse – the problem was in the functioning of the market, not a lack of demand for the assets. It would be fair to say that the corporate bond scheme attracted some criticism in its early months. Many observers misunderstood the nature and purpose of the scheme and considered that the small amounts bought were a sign of failure. But, as I have stressed tonight, the objectives of the scheme were not based on buying a particular amount. In fact, over the past year, the corporate bond market overall has performed consistently strongly and in line with the original objectives of the scheme: There has been record issuance of sterling corporate bonds (Chart 5); spreads for eligible bonds have halved (Chart 6); bid-offer spreads have narrowed; and the bond-CDS basis 6 has also contracted significantly. These asset purchases do seem to have played their part in improving the access of investment grade corporates to bond market financing. The one disappointing feature of the sterling corporate bond market is the continuing problem of secondary market illiquidity.