Working Paper: NBER ID: w12937
Authors: Fabio Ghironi; Jaewoo Lee; Alessandro Rebucci
Abstract: Ongoing international financial integration has greatly increased foreign asset holdings across countries, enhancing the scope for a "valuation channel" of external adjustment (i.e., the changes in a country's net foreign asset position due to exchange rate and asset price changes). We examine this channel of adjustment in a dynamic stochastic general equilibrium model with international equity trading in incomplete asset markets. We show that the risk-sharing properties of international equity trading are tied to the distribution of income between labor income and profits when equities are defined as claims to firm profits in a production economy. For a given level of international financial integration (measured by the size of gross foreign asset positions), the quantitative importance of the valuation channel of external adjustment depends on features of the international transmission mechanism such as the size of financial frictions, substitutability across goods, and the persistence of shocks. Finally, moving from less to more international financial integration, risk sharing through asset markets increases, and valuation changes are larger, but their relative importance in net foreign asset dynamics is smaller.
Keywords: valuation channel; external adjustment; international financial integration; dynamic stochastic general equilibrium; risk-sharing
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 |
|---|---|
| international financial integration (F30) | risk-sharing properties of international equity trading (G15) |
| risk-sharing properties of international equity trading (G15) | valuation changes (D46) |
| valuation changes (D46) | net foreign asset dynamics (F32) |
| distribution of income between labor income and profits (D33) | valuation channel (G19) |
| initial asset positions and economic features (like financial frictions) (G19) | magnitude and significance of valuation channel (G19) |
| asset valuations (G32) | current account movements (F32) |
| equity markets (G10) | consumption dynamics (E21) |