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Trend Shocks, Risk Sharing and Cross-Country Portfolio Holdings

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  • Yavuz Arslan
  • Gursu Keles
  • Mustafa Kilinc

Abstract

This paper analyzes the dynamics of risk premia, real exchange rates and portfolio movements in a two-country, two-good, two-bond model. We use an asymmetric set-up in the model, where one of the countries is emerging and the other one is developed and both countries issue bonds in domestic currency. The emerging country di¤ers from the developed country in that it is subject to trend shocks and it is more risk averse. We find that the trend shocks produce strong wealth e¤ects for the emerging country, and as a result, the terms of trade and the real exchange rate appreciate. Appreciation of the terms of trade breaks the hedging opportunities coming from international trade in goods. In contrast, the appreciation of the real exchange rate generates new hedging opportunities in international financial markets for both countries. Therefore, our model can endogenously generate large portfolio holdings. And di¤erences in the risk aversion across countries lead to net positive foreign asset positions and signi?cant risk premia in the emerging country. Moreover, the relative volatilities and cyclicalities of risk premia and real exchange rates improve significantly and move closer to the observed values in the data and our model can account for the lack of international risk sharing.

Suggested Citation

  • Yavuz Arslan & Gursu Keles & Mustafa Kilinc, 2012. "Trend Shocks, Risk Sharing and Cross-Country Portfolio Holdings," Working Papers 1205, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  • Handle: RePEc:tcb:wpaper:1205
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    Cited by:

    1. Arslan, Yavuz & Kılınç, Mustafa & Turhan, M. İbrahim, 2015. "Global imbalances, current account rebalancing and exchange rate adjustments," Journal of Policy Modeling, Elsevier, vol. 37(2), pages 324-341.
    2. Akkoyun, Hüseyin Çağrı & Arslan, Yavuz & Kılınç, Mustafa, 2017. "Risk sharing and real exchange rates: The role of non-tradable sector and trend shocks," Journal of International Money and Finance, Elsevier, vol. 73(PA), pages 232-248.

    More about this item

    Keywords

    Risk sharing; Risk premium; Exchange rates; Trend shocks; Portfolio movements;

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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