Its origin is rooted in the 1957 Treaty of Rome establishing the European Economic Community. At this point Belgium, France, Germany, Italy, Luxembourg and the  1  Schumpeter (1976, p. 83). 2  See IMF (1997). 3  For a historical overview of globalisation and its economic implications, see Williamson (1996), and Obstfeld and Taylor (2005). BIS Review 43/2006  1  Netherlands wished to remove economic barriers among Member States, but wanted to remain within the Bretton Woods system of stable exchange rates. In 1969, when the Bretton Woods system appeared on the verge of collapse, the European leaders of the time were already thinking about creating their own alternative system of stable exchange rates among the European currencies. Three key initiatives leading towards EMU can be highlighted: the Werner Report in 1970, which introduced the concept of the “Snake in the Tunnel” that was later launched before the end of the Bretton Woods system in 1973; the European Monetary System in 1979, involving the introduction of the European Currency Unit; and the Delors Report in 1989, which is reflected in the Maastricht treaty in 1991. The years since 1969 depict a period of repeated attempts to establish a zone of exchange rate stability in (Western) Europe. 4 These initiatives can also be seen in the context of the globalisation process.
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.