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A simple model of international capital flows, exchange rate risk, and portfolio choice

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  • Rowena A. Pecchenino
  • Patricia S. Pollard

Abstract

This paper examines international capital flows in the context of a simple Diamond-Dybvig model in which there are neither moral hazard nor adverse selection problems, thus isolating exchange rate risk as the propagator of capital flows. The model shows that adverse changes in exchange rate expectations can result in \"hot money\" flows even when a bank's balance sheet is perfectly transparent and its assets have a positive net present value in local currency terms. The model also indicates that foreign deposit guarantees even in the absence of a change in the bank's portfolio can increase the chance of bank runs.

Suggested Citation

  • Rowena A. Pecchenino & Patricia S. Pollard, 2003. "A simple model of international capital flows, exchange rate risk, and portfolio choice," Working Papers 2000-009, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2000-009
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    References listed on IDEAS

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    Keywords

    Capital movements; Foreign exchange;

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