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A Portfolio Theory of International Capital Flows

  • Michael B. Devereux
  • Makoto Saito

This paper constructs a model in which the currency composition of national portfolios is an essential element in facilitating capital ‡ows between countries. In a two country environment, each country chooses optimal nominal bond portfolios in face of real and nominal risk.Current account deficits are financed by increases in domestic currency debt, but balanced by increases in foreign currency credit. This is combined with an evolution of risk-premiums such that the rate of return on the debtor country’s gross liabilities is lower than the return on its gross assets. This ensures stability of the world wealth distribution.

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Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp124.

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Date of creation: 05 Apr 2006
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Handle: RePEc:iis:dispap:iiisdp124
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  1. Michael P. Dooley & Peter Isard, 1979. "The portfolio-balance model of exchange rates," International Finance Discussion Papers 141, Board of Governors of the Federal Reserve System (U.S.).
  2. Jonathan Heathcote & Fabrizio Perri, 2004. "The international diversification puzzle is not as bad as you think," 2004 Meeting Papers 152, Society for Economic Dynamics.
  3. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
  4. Gian-Maria Milesi-Ferretti & Philip R. Lane, 1999. "The External Wealth of Nations: Measures of Foreign Assets and Liabilities for Industrial and Developing Countries," IMF Working Papers 99/115, International Monetary Fund.
  5. Maurice Obstfeld & Kenneth Rogoff, 2004. "The Unsustainable US Current Account Position Revisited," NBER Working Papers 10869, National Bureau of Economic Research, Inc.
  6. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2004. "Financial Globalization and Exchange Rates," CEPR Discussion Papers 4745, C.E.P.R. Discussion Papers.
  7. Pierre-Olivier Gourinchas & Hélène Rey, 2005. "International Financial Adjustment," International Finance 0505004, EconWPA.
  8. Maurice Obstfeld & Kenneth Rogoff, 1994. "The Intertemporal Approach to the Current Account," NBER Working Papers 4893, National Bureau of Economic Research, Inc.
  9. Charles Engel & Akito Matsumoto, 2006. "Portfolio Choice in a Monetary Open-Economy DSGE Model," NBER Working Papers 12214, National Bureau of Economic Research, Inc.
  10. Obstfeld, Maurice & Rogoff, Kenneth, 2001. "Global Implications of Self-Orientated National Monetary Rules," CEPR Discussion Papers 2856, C.E.P.R. Discussion Papers.
  11. Tille, Cédric, 2008. "Financial integration and the wealth effect of exchange rate fluctuations," Journal of International Economics, Elsevier, vol. 75(2), pages 283-294, July.
  12. Neumeyer, P.A., 1995. "Currencies and the Allocation of Risk: The Welfare Effect of a Monetary Union," DELTA Working Papers 95-27, DELTA (Ecole normale supérieure).
  13. Anna Pavlova & Roberto Rigobon, 2003. "Asset Prices and Exchange Rates," NBER Working Papers 9834, National Bureau of Economic Research, Inc.
  14. Baxter, Marianne & Jermann, Urban J, 1997. "The International Diversification Puzzle Is Worse Than You Think," American Economic Review, American Economic Association, vol. 87(1), pages 170-80, March.
  15. Finn E. Kydland & Edward C. Prescott, 1990. "Business cycles: real facts and a monetary myth," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 3-18.
  16. Hnatkovska, Viktoria, 2010. "Home bias and high turnover: Dynamic portfolio choice with incomplete markets," Journal of International Economics, Elsevier, vol. 80(1), pages 113-128, January.
  17. Saito, Makoto, 1997. "A note on ergodic distributions in two-agent economies," Journal of Mathematical Economics, Elsevier, vol. 27(2), pages 133-141, March.
  18. Maurice Obstfeld, 2004. "External Adjustment," NBER Working Papers 10843, National Bureau of Economic Research, Inc.
  19. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  20. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
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