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Shifts in portfolio preferences of international investors: an application to sovereign wealth funds

Author

Listed:
  • Filipa Sá

    () (University of Cambridge)

  • Francesca Viani

    () (Banco de España)

Abstract

Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterised by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the consequences of an increase in the importance of sovereign wealth funds (SWFs). Specifically, we ask what would happen if ‘excess’ reserves held by emerging markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the ‘exorbitant privilege’, ie, the excess return the United States receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.

Suggested Citation

  • Filipa Sá & Francesca Viani, 2011. "Shifts in portfolio preferences of international investors: an application to sovereign wealth funds," Working Papers 1112, Banco de España;Working Papers Homepage.
  • Handle: RePEc:bde:wpaper:1112
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    File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/11/Fich/dt1112e.pdf
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    References listed on IDEAS

    as
    1. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2007. "The external wealth of nations mark II: Revised and extended estimates of foreign assets and liabilities, 1970-2004," Journal of International Economics, Elsevier, vol. 73(2), pages 223-250, November.
    2. Jonathan Heathcote & Fabrizio Perri, 2013. "The International Diversification Puzzle Is Not as Bad as You Think," Journal of Political Economy, University of Chicago Press, vol. 121(6), pages 1108-1159.
    3. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2008. "An Equilibrium Model of "Global Imbalances" and Low Interest Rates," American Economic Review, American Economic Association, vol. 98(1), pages 358-393, March.
    4. Maurice Obstfeld & Kenneth S. Rogoff, 2005. "Global Current Account Imbalances and Exchange Rate Adjustments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 67-146.
    5. Forbes, Kristin J., 2010. "Why do foreigners invest in the United States?," Journal of International Economics, Elsevier, vol. 80(1), pages 3-21, January.
    6. Indradeep Ghosh, 2011. "Imperfect Asset Substitutability and Current Account Dynamics," Review of Development Economics, Wiley Blackwell, vol. 15(1), pages 66-77, February.
    7. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
    8. Guy M Meredith, 2007. "Debt Dynamics and Global Imbalances; Some Conventional Views Reconsidered," IMF Working Papers 07/4, International Monetary Fund.
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    Citations

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    Cited by:

    1. Sa, Filipa & Towbin, Pascal & wieladek, tomasz, 2011. "Low interest rates and housing booms: the role of capital inflows, monetary policy and financial innovation," Bank of England working papers 411, Bank of England.
    2. Nikolay Hristov & Oliver Hülsewig & Timo Wollmershäuser, 2018. "Capital Flows in the Euro Area and TARGET2 Balances," CESifo Working Paper Series 6877, CESifo Group Munich.
    3. repec:kap:iecepo:v:14:y:2017:i:4:d:10.1007_s10368-016-0342-6 is not listed on IDEAS
    4. Sa, Filipa & Wieladek, Tomasz, 2010. "Monetary policy, capital inflows and the housing boom," Bank of England working papers 405, Bank of England.
    5. Wollmershäuser, Timo, 2018. "Capital Flows in the Euro Area and TARGET2 Balances," Annual Conference 2018 (Freiburg, Breisgau): Digital Economy 181648, Verein für Socialpolitik / German Economic Association.
    6. Steiner, Andreas, 2014. "Current account balance and dollar standard: Exploring the linkages," Journal of International Money and Finance, Elsevier, vol. 41(C), pages 65-94.

    More about this item

    Keywords

    portfolio preferences; sudden stops; imperfect substitutability; global imbalances; sovereign wealth funds;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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