Working Paper: NBER ID: w30738
Authors: J. Scott Davis; Eric Van Wincoop
Abstract: We develop a theory to account for changes in gross and net capital flows over the global financial cycle (GFC). The theory relies critically on portfolio heterogeneity among investors within and across countries, related to risky portfolio shares and portfolio shares allocated to foreign assets. A global drop in risky asset prices during a downturn of the GFC changes relative wealth within and across countries due to portfolio heterogeneity. This leads to changes in gross and net capital flows that are consistent with the stylized facts: all countries experience a decline in gross capital flows (retrenchment), while countries that have a net debt of safe assets experience a rise in net outflows of safe assets (reduced accumulation of safe debt). This is accomplished through a rise in total net outflows and a drop in net outflows of risky assets. The model is applied to 20 advanced countries and calibrated to micro data related to within country portfolio heterogeneity, as well as cross country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for gross and net capital flows are quantitatively consistent with the data.
Keywords: No keywords provided
JEL Codes: F30; F40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| drop in global risky asset prices (G19) | decline in gross capital flows (F32) |
| drop in global risky asset prices (G19) | changes in relative wealth (D31) |
| changes in relative wealth (D31) | decline in gross capital flows (F32) |
| negative net foreign asset position in safe assets (F32) | rise in net outflows of safe assets (F32) |
| rise in net outflows of safe assets (F32) | increased saving (D14) |
| rise in net outflows of safe assets (F32) | decreased investment (E22) |
| increased saving (D14) | increase in net capital outflows of safe assets (F32) |
| decreased investment (E22) | increase in net capital outflows of safe assets (F32) |