Working Paper: CEPR ID: DP1569
Authors: Philippe Bacchetta; Eric van Wincoop
Abstract: Nominal assets play a major role in international financial markets, while trade in indexed bonds is not empirically relevant. As a result, agents are generally exposed to both price and exchange rate uncertainty. Nonetheless, previous research on net capital flows has assumed the presence of a risk-free vehicle to intertemporal asset trade. In this paper, we present a general equilibrium intertemporal model with trade limited to nominal bonds and equity. We find that the absence of a risk-free bond generally dampens net capital flows, thus making economies effectively more closed.
Keywords: exchange rate uncertainty; nominal risk; net capital flows
JEL Codes: F32; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| absence of a risk-free bond (G12) | dampens net capital flows (F32) |
| nominal risk (D80) | economies become more closed (P19) |
| higher risk aversion (D81) | smaller net capital flows (F32) |
| lower elasticity of intertemporal substitution (D15) | smaller net capital flows (F32) |
| exchange rate uncertainty (F31) | larger dampening effect on net capital flows (F32) |
| inflation risk (E31) | smaller dampening effect on net capital flows (F32) |
| individuals' perceptions of uncertainty about foreign monetary policy (F31) | dampening effect on net capital flows (F32) |