Working Paper: CEPR ID: DP10564
Authors: Fabio Ghironi; Jaewoo Lee; Alessandro Rebucci
Abstract: International financial integration has greatly increased the scope for changes in a country?s net foreign asset position through the ?valuation channel? of external adjustment, namely capital gains and losses on the country?s external assets and liabilities. We examine this valuation channel theoretically in a dynamic equilibrium portfolio model with international trade in equity that encompasses complete and incomplete asset market scenarios. By separating asset prices and quantities in the definition of net foreign assets, we can characterize the first-order dynamics of both valuation effects and net foreign equity holdings. First-order excess returns are unanticipated and i.i.d. in our model, but capital gains and losses on equity positions feature persistent, anticipated dynamics in response to productivity shocks. The separation of prices and quantities in net foreign assets also enables us to characterize fully the role of capital gains and losses versus the current account in the dynamics of macroeconomic aggregates. Specifically, we disentangle the roles of excess returns, capital gains, and portfolio adjustment for consumption risk sharing when financial markets are incomplete, showing how these different channels contribute to dampening (or amplifying) the impact response of the cross-country consumption differential to shocks and to keeping it constant in subsequent periods.
Keywords: current account; equity; net foreign assets; risk sharing; valuation
JEL Codes: F32; F41; G11; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| valuation channel of external adjustment (F32) | capital gains and losses on the stock of gross foreign assets and liabilities (F21) |
| unexpected asset price changes (G19) | initial response of valuation to a shock (G19) |
| productivity shocks (O49) | response of valuation channel characterized by AR(1) process (C22) |
| government spending shocks (E62) | response of valuation channel characterized by iid (G19) |
| productivity shock (O49) | share of valuation in net foreign asset adjustment (F32) |
| government spending shocks (E62) | share of valuation in net foreign asset adjustment (F32) |
| valuation effects (Q51) | net foreign asset changes following productivity shocks (O49) |
| portfolio adjustment (G11) | net foreign asset movements in response to government spending shocks (F32) |