The valuation channel of external adjustment. (October 2015)

• Record Type: Journal Article
• Authors: Ghironi, Fabio; Lee, Jaewoo; Rebucci, Alessandro
• Is Part Of: Journal of international money and finance. Volume 57(2015)
• Page Start: 86
• Page End: 114
• Publication Date: 2015-10
• Subjects: Current account -- Equity -- Net foreign assets -- Risk sharing -- Valuation; F32 -- F41 -- G11 -- G15; International finance -- Periodicals; Foreign exchange -- Periodicals; Finances internationales -- Périodiques; Change -- Périodiques; Foreign exchange; International finance; Periodicals; 332.04205
• DOI: 10.1016/j.jimonfin.2015.06.004
• Languages: English
• ISSNs: 0261-5606

Abstract

Highlights: We examine the valuation channel of net foreign asset adjustment. Separating prices and quantities allows us to study first-order valuation and portfolio changes. Capital gains and losses feature persistent, anticipated dynamics after productivity shocks. We study how capital gains and the current account affect dynamics of macroeconomic aggregates. We disentangle the roles of returns, capital gains, and portfolio adjustment for risk sharing. 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.