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A Portfolio Model of Capital Flows to Emerging Markets

  • Michael B Devereux

    (University of British Columbia, Canada)

  • Alan Sutherland

    (University of St Andrews, UK)

Since the crises of the late 1990's, most emerging market economies have built up substantial positive holdings of US dollar treasury bills, while at the same time experiencing a boom in FDI capital inflows. This paper develops a DSGE model of the interaction between an emerging market economy and an advanced economy which incorporates two-way capital flows between the economies. The novel aspect of the paper is to make use of new methods for analyzing portfolio choice in DSGE models. We compare a range of alternative financial market structures, in each case computing equilibrium portfolios. We find that an asymmetric configuration where the emerging economy holds nominal bonds and issues claims on capital (FDI) can achieve a considerable degree of international risk-sharing. This risk-sharing can be enhanced by a more stable monetary policy in the advanced economy.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 082009.

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Length: 38 pages
Date of creation: Feb 2009
Date of revision:
Handle: RePEc:hkm:wpaper:082009
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  1. Ricardo J. Caballero G. & Stavros Panageas, 2005. "Contingent Reserves Management: an Applied Framework," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 8(2), pages 45-56, August.
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  4. Schmitt-Grohé, Stephanie & Uribe, Martín, 2002. "Closing Small Open Economy Models," CEPR Discussion Papers 3096, C.E.P.R. Discussion Papers.
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  7. Cedric Tille, 2005. "Financial integration and the wealth effect of exchange rate fluctuations," Staff Reports 226, Federal Reserve Bank of New York.
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  9. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2005. "A Global Perspective on External Positions," CEPR Discussion Papers 5234, C.E.P.R. Discussion Papers.
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  13. repec:tcd:wpaper:tep16 is not listed on IDEAS
  14. Baxter, M. & Jermann, U.J., 1993. "The International Diversification Puzzle is Worse than you Think," RCER Working Papers 350, University of Rochester - Center for Economic Research (RCER).
  15. Javier García-Cicco & Roberto Pancrazi & Martín Uribe, 2006. "Real Business Cycles in Emerging Countries?," NBER Working Papers 12629, National Bureau of Economic Research, Inc.
  16. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
  17. Gian-Maria Milesi-Ferretti & Philip R. Lane, 2005. "A Global Perspectiveon External Positions," IMF Working Papers 05/161, International Monetary Fund.
  18. Samuelson, Paul A, 1970. "The Fundamental Approximation Theorem of Portfolio Analysis in terms of Means, Variances, and Higher Moments," Review of Economic Studies, Wiley Blackwell, vol. 37(4), pages 537-42, October.
  19. Cedric Tille, 2003. "The impact of exchange rate movements on U.S. foreign debt," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 9(Jan).
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