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Why are Countries’ Asset Portfolios Exposed to Nominal Exchange Rates?

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  • Jonathan J. Adams
  • Mr. Philip Barrett

Abstract

Most countries hold large gross asset positions, lending in domestic currency and borrowing in foreign. Thus, their balance sheets are exposed to nominal exchange rates. We argue that when asset markets are incomplete, nominal exchange rate exposure allows countries to partially insure against shocks that move real exchange rates. We demonstrate that asset market incompleteness can simultaneously generate realistic gross asset positions and resolve the Backus-Smith puzzle: that relative consumptions and real exchange rates correlate negatively. We also show that local perturbation methods that use stabilizing endogenous discount factors are inaccurate when average and steady state interest rates differ. To address this, we develop a novel global solution method to accurately solve the model.

Suggested Citation

  • Jonathan J. Adams & Mr. Philip Barrett, 2017. "Why are Countries’ Asset Portfolios Exposed to Nominal Exchange Rates?," IMF Working Papers 2017/291, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:2017/291
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    More about this item

    Keywords

    WP; exchange rate; Country portfolios; international business cycles; home bias; gross asset positions; exchange rates; Backus-Smith puzzle; asset market incompleteness; Backus-Smith correlation; goods firm; consumption puzzle; interest rate parity; price level; asset dynamics; Real exchange rates; Consumption; Bonds; Securities markets; Global;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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