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The Risk Premium and Long-Run Global Imbalances

  • YiLi Chien

    (Federal Reserve Bank of St. Louis)

  • Kanda Naknoi

    (University of Connecticut)

This study proposes that heterogeneous household portfolio choices within a country and across countries offer an explanation for global imbalances. We construct a stochastic growth multi-country model in which heterogeneous agents face the following restrictions on asset trade. First, the degree of US equity market participation is higher than that of the rest of the world. Second, a fraction of households in every country maintains a fixed share of equity in their portfolios. In our calibrated model, which matches the US net foreign asset position and the equity premium, the average US household loads up more aggregate risk than the average foreign household by investing in a risky asset abroad and issuing a risk-free asset. As a result, the US is compensated by a high risk premium and runs trade deficits even as a debtor country. The long-run average trade deficit in our model accounts for more than 50% of the observed US trade deficit.

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Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2012-41.

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Length: 49 pages
Date of creation: Nov 2012
Date of revision:
Handle: RePEc:uct:uconnp:2012-41
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