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Why are countries’ asset portfolios exposed to nominal exchange rates?

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  • Adams, Jonathan J.
  • Barrett, Philip

Abstract

Most countries hold large gross asset positions, lending in their domestic currency and borrowing in foreign currency. As a result, their balance sheets are exposed to nominal exchange rate movements. We argue that when asset markets are incomplete, this exposure provides partial insurance against shocks that move exchange rates. We demonstrate that this insurance motive can simultaneously generate realistic gross asset positions and resolve the Backus-Smith puzzle: that countries’ relative consumption and real exchange rates are negatively correlated. Local perturbation methods are inaccurate in this setting as they approximate around the wrong interest rate, even when they correctly characterize the average portfolio holdings. So to accurately solve the equilibrium portfolio problem, we extend Maliar and Maliar (2015)’s global projection method.

Suggested Citation

  • Adams, Jonathan J. & Barrett, Philip, 2021. "Why are countries’ asset portfolios exposed to nominal exchange rates?," Journal of International Money and Finance, Elsevier, vol. 110(C).
  • Handle: RePEc:eee:jimfin:v:110:y:2021:i:c:s0261560620302333
    DOI: 10.1016/j.jimonfin.2020.102277
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    More about this item

    Keywords

    Country portfolios; International business cycles; Home bias; Gross asset positions; Exchange rates; Backus-Smith puzzle;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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