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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. Akito Matsumoto & Charles Engel, 2005. "Portfolio Choice in a Monetary Open-Economy DSGE Model," IMF Working Papers 05/165, International Monetary Fund.
  2. Pierre-Olivier Gourinchas & Hélène Rey, 2005. "International Financial Adjustment," International Finance 0505004, EconWPA.
  3. Maurice Obstfeld & Kenneth Rogoff, 2002. "Global Implications Of Self-Oriented National Monetary Rules," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 503-535, May.
  4. Jonathan Heathcote & Fabrizio Perri, 2007. "The international diversification puzzle is not as bad as you think," Staff Report 398, Federal Reserve Bank of Minneapolis.
  5. Philip Lane & Gian Maria Milesi-Ferretti, 2001. "THE EXTERNAL WEALTH OF NATIONS: Measures of Foreign Assets and Liabilities For Industrial and Developing Countries," CEG Working Papers 20012, Trinity College Dublin, Department of Economics.
  6. Maurice Obstfeld & Kenneth Rogoff & Richard Clarida, . "The Unsustainable U S Current Account Position Revisited," Working Paper 14901, Harvard University OpenScholar.
  7. Pavlova, Anna & Rigobon, Roberto, 2004. "Asset Prices and Exchange Rates," Working papers 4322-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  8. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2004. "Financial Globalization and Exchange Rates," CEPR Discussion Papers 4745, C.E.P.R. Discussion Papers.
  9. 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).
  10. 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).
  11. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
  12. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  13. 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.
  14. Maurice Obstfeld, 2004. "External Adjustment," NBER Working Papers 10843, National Bureau of Economic Research, Inc.
  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. 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.).
  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. 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.
  19. Cedric Tille, 2005. "Financial integration and the wealth effect of exchange rate fluctuations," Staff Reports 226, Federal Reserve Bank of New York.
  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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