Asset Prices, News Shocks, and the Trade Balance

We analyze the relationship between asset prices and the trade balance estimating a Bayesian VAR for a broad set of 38 industrialized and emerging market countries. To derive model‐based identifying restrictions, we model asset price shocks as news shocks about future productivity in a two‐country dynamic stochastic general equilibrium model. Such shocks are found to exert sizable effects on the trade balance. Moreover, the effects are highly heterogeneous across countries. For instance, following a news shock that implies on impact a 10% increase in domestic equity prices relative to the rest of the world, the U.S. trade balance will worsen by up to 1.0 percentage points, but much less so for most other economies. We find that this heterogeneity appears to be linked to the financial market depth and equity home bias of countries. Moreover, the channels via wealth effects and via the real exchange rate are important for understanding the heterogeneity in the transmission.