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The Valuation Channel of External Adjustment in Small Open Economies

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  • Aquino, Juan Carlos

    (Banco Central de Reserva del Perú)

Abstract

A common problem in international finance consists of the indeterminacy of the equilibrium asset portfolio in small open economy models. This paper develops a simple approach to compute this portfolio under the assumption of incomplete financial markets. The procedure involves the limiting allocation of a class of two-country world economies where the relative size of one of them tends to zero. Such approach allows to identify the effect of portfolio decisions on the dynamics of the net foreign asset position of a small open economy in a structural fashion. As an illustration, an approximated closed-form solution is obtained for a highly stylized model that is isomorphic to the class of Dynamic Stochastic General Equilibrium (DSGE) models typically used in the literature. JEL Classification: F32. Keywords: net foreign assets, endogenous portfolios, small open economies, DSGE models.

Suggested Citation

  • Aquino, Juan Carlos, 2018. "The Valuation Channel of External Adjustment in Small Open Economies," Working Papers 2018-011, Banco Central de Reserva del Perú.
  • Handle: RePEc:rbp:wpaper:2018-011
    as

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    References listed on IDEAS

    as
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    3. Jonathan Heathcote & Fabrizio Perri, 2013. "The International Diversification Puzzle Is Not as Bad as You Think," Journal of Political Economy, University of Chicago Press, vol. 121(6), pages 1108-1159.
    4. Rabitsch, Katrin & Stepanchuk, Serhiy, 2014. "A two-period model with portfolio choice: Understanding results from different solution methods," Economics Letters, Elsevier, vol. 124(2), pages 239-242.
    5. Grzegorz R. Dlugoszek, 2016. "Solving DSGE Portfolio Choice Models with Asymmetric Countries," SFB 649 Discussion Papers SFB649DP2016-009, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
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    More about this item

    Keywords

    net foreign assets; endogenous portfolios; small open economies; DSGE models;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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