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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
Date of revision:
Handle: RePEc:iis:dispap:iiisdp124
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  1. Obstfeld, Maurice & Rogoff, Kenneth S, 2005. "The Unsustainable US Current Account Position Revisited," Center for International and Development Economics Research, Working Paper Series qt4f63x50j, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  2. Pierre-Olivier Gourinchas & Helene Rey, 2005. "International Financial Adjustment," NBER Working Papers 11155, National Bureau of Economic Research, Inc.
  3. Fabrizio Perri & Jonathan Heathcote, 2007. "The International Diversification Puzzle Is Not as Bad as You Think," Working Papers 2007-3, University of Minnesota, Department of Economics, revised 08 Oct 2007.
  4. 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.
  5. Maurico Obstfeld, 2004. "External adjustment," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 140(4), pages 541-568, December.
  6. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "The intertemporal approach to the current account," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 34, pages 1731-1799 Elsevier.
  7. Gian-Maria Milesi-Ferretti & Philip R. Lane, 2005. "Financial Globalization and Exchange Rates," IMF Working Papers 05/3, International Monetary Fund.
  8. Maurice Obstfeld and Kenneth Rogoff., 2001. "Global Implications of Self-Oriented National Monetary Rules," Center for International and Development Economics Research (CIDER) Working Papers C01-120, University of California at Berkeley.
  9. 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).
  10. Saito, Makoto, 1997. "A note on ergodic distributions in two-agent economies," Journal of Mathematical Economics, Elsevier, vol. 27(2), pages 133-141, March.
  11. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
  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. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 1999. "The External Wealth of Nations: Measures of Foreign Assets and Liabilities for Industrial and Developing Countries," CEPR Discussion Papers 2231, C.E.P.R. Discussion Papers.
  14. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  15. Kollmann, Robert, 2006. "International Portfolio Equilibrium and the Current Account," CEPR Discussion Papers 5512, C.E.P.R. Discussion Papers.
  16. Anna Pavlova & Roberto Rigobon, 2003. "Asset Prices and Exchange Rates," NBER Working Papers 9834, National Bureau of Economic Research, Inc.
  17. Charles Engel & Akito Matsumoto, 2006. "Portfolio Choice in a Monetary Open-Economy DSGE Model," NBER Working Papers 12214, National Bureau of Economic Research, Inc.
  18. 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.).
  19. 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.
  20. 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.
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