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The valuation channel of external adjustment

Author

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  • 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.

Suggested Citation

  • Fabio Ghironi & Jaewoo Lee & Alessandro Rebucci, 2009. "The valuation channel of external adjustment," Working Papers 09-18, Federal Reserve Bank of Boston.
    • Handle: RePEc:fip:fedbwp:09-18
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    More about this item

    Keywords

    Balance of payments;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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