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A Portfolio Theory of International Capital Flows

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  • Michael B. Devereux

    (University of British Columbia)

  • Makoto Saito

    (Hitotsubashi University)

Abstract

This paper constructs a model in which the currency composition of national portfolios is an essential element in facilitating capital flows between countries. In a two country environment, each country chooses optimal nominal bond portfolios in face of real and nominal risk. Current account deficits are financed by increases in domestic currency debt, but balanced by increases in foreign currency credit. This is combined with an evolution of risk-premiums such that the rate of return on the debtor country¡¦s gross liabilities is lower than the return on its gross assets. This ensures stability of the world wealth distribution.

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Bibliographic Info

Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 112006.

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Length: 31 pages
Date of creation: Sep 2006
Date of revision:
Handle: RePEc:hkm:wpaper:112006

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  1. Baxter, Marianne & Jermann, Urban J, 1997. "The International Diversification Puzzle Is Worse Than You Think," American Economic Review, American Economic Association, vol. 87(1), pages 170-80, March.
  2. Jonathan Heathcote & Fabrizio Perri, 2013. "The international diversification puzzle is not as bad as you think," Working Papers 472, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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  7. Maurice Obstfeld & Kenneth Rogoff, 2007. "The Unsustainable U.S. Current Account Position Revisited," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 339-376 National Bureau of Economic Research, Inc.
  8. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
  9. Anna Pavlova & Roberto Rigobon, 2007. "Asset Prices and Exchange Rates," Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1139-1180.
  10. Maurice Obstfeld, 2004. "External Adjustment," NBER Working Papers 10843, National Bureau of Economic Research, Inc.
  11. Pierre-Olivier Gourinchas & Helene Rey, 2005. "International Financial Adjustment," NBER Working Papers 11155, National Bureau of Economic Research, Inc.
  12. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
  13. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2001. "The external wealth of nations: measures of foreign assets and liabilities for industrial and developing countries," Journal of International Economics, Elsevier, vol. 55(2), pages 263-294, December.
  14. Maurice Obstfeld and Kenneth Rogoff., 1994. "The Intertemporal Approach to the Current Account," Center for International and Development Economics Research (CIDER) Working Papers C94-044, University of California at Berkeley.
  15. Obstfeld, Maurice & Rogoff, Kenneth, 2001. "Global Implications of Self-Oriented National Monetary Rules," Center for International and Development Economics Research, Working Paper Series qt6412m5b7, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  16. Tille, Cédric, 2008. "Financial integration and the wealth effect of exchange rate fluctuations," Journal of International Economics, Elsevier, vol. 75(2), pages 283-294, July.
  17. Saito, Makoto, 1997. "A note on ergodic distributions in two-agent economies," Journal of Mathematical Economics, Elsevier, vol. 27(2), pages 133-141, March.
  18. Michael P. Dooley & Peter Isard, 1979. "The portfolio-balance model of exchange rates," International Finance Discussion Papers 141, Board of Governors of the Federal Reserve System (U.S.).
  19. Hnatkovska, Viktoria, 2010. "Home bias and high turnover: Dynamic portfolio choice with incomplete markets," Journal of International Economics, Elsevier, vol. 80(1), pages 113-128, January.
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