Working Paper: NBER ID: w13908
Authors: Kristin J. Forbes
Abstract: Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and there is no evidence that foreigners invest in the United States based on diversification motives. The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.
Keywords: Foreign Investment; Global Imbalances; Financial Markets
JEL Codes: F2; F3; F4; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial market development (O16) | Foreign investment in U.S. assets (F21) |
| Income per capita (D31) | Financial market development (O16) |
| Capital controls (F38) | Foreign investment in U.S. assets (F21) |
| Trade relations (F10) | Foreign investment in U.S. assets (F21) |
| Return differentials (C69) | Foreign investment in U.S. assets (F21) |
| Cultural ties (Z10) | Foreign investment in U.S. assets (F21) |
| Stronger corporate governance (G38) | Foreign investment in U.S. assets (F21) |
| Underperformance in own equity markets (G15) | Foreign investment in U.S. assets (F21) |