History, gravity and international finance

• We analyse bilateral US foreign bond holdings.
• We show that holdings seven decades ago still influence holdings today.
• This “history effect” explains 10–15% of the cross-country variation in holdings now.
• It also reflects fixed costs of investment together with endogenous learning.
• History and path dependence are hence key sources of financial segmentation.

We analyse patterns of bilateral financial investment using data on US holdings of foreign bonds. We document a “history effect” in which holdings seven decades ago continue to influence holdings today. 10–15% of the cross-country variation in US investors' foreign bond holdings is explained by holdings 70 years ago, plausibly reflecting fixed costs of market entry and exit and endogenous learning. This effect is twice as large for bonds denominated in currencies other than the dollar, suggesting the existence of even higher fixed costs of initiating US foreign investment in such currencies. Our findings point to history and path dependence as key sources of financial market segmentation.