The authors consider external sustainability from the perspective of equilibrium in net foreign asset positions. Under their approach, an external situation is sustainable if it is consistent with international and domestic investors'achieving their desired portfolio allocation across countries. They develop a reduced-form model of net foreign asset positions whose long-run equilibrium condition expresses the ratio of net foreign assets to the total wealth of domestic residents as a negative function of investment returns in the country relative to the rest of the world, a positive function of investment risk, and an inverse function of the ratio of foreign-owned to domestically owned wealth. To estimate this equilibrium condition, the authors use a newly constructed data set of foreign asset and liability stocks for a large group of industrial and developing countries, from the 1960s to the present. They also develop summary measures of country returns and risks. Their econometric methodology is an application of the Pooled Mean Group estimator recently developed by Pesaran, Shin, and Smith (1999), which allows for unrestricted cross-country heterogeneity in short-term dynamics while imposing a common long-run specification. The estimation results lend considerable support to the model, especially when applied to countries with low capital controls or high or upper-middle income. The results for countries with high capital controls and, especially, lower-income countries are less supportive of the stock equilibrium model. As a by-product of the model's estimation, the authors obtain estimates of the long-run equilibrium ratios of net foreign assets to wealth, conditional on the observed values of the country's relative returns, risks, and wealth. Then, for a selected group of industrial and developing countries, they evaluate the extent to which actual ratios diverge from their long-run counterparts - and hence the sustainability of current net foreign asset positions.
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Aart Kraay & Norman Loayza & Luis Servén & Jaume Ventura, 2000.
"Country portfolios,"
Economics Working Papers
913, Department of Economics and Business, Universitat Pompeu Fabra.
[Downloadable!]
Aart Kraay & Norman Loayza & Luis Serven & Jaume Ventura, 2000.
"Country Portfolios,"
NBER Working Papers
7795, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
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