Equilibrium Portfolios and External Adjustment Under Incomplete Markets

41 Pages Posted: 20 Mar 2008 Last revised: 28 Mar 2012

See all articles by Anna Pavlova

Anna Pavlova

London Business School; Centre for Economic Policy Research (CEPR)

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: March 27, 2012

Abstract

Recent evidence on the importance of cross-border equity flows calls for a rethinking of the standard theory of external adjustment. We introduce equity holdings and portfolio choice into an otherwise conventional open-economy dynamic equilibrium model. Our model is simple and it admits an exact closed-form solution regardless of whether financial markets are complete or incomplete. In this simple framework, we are able to establish interconnections between the real side of the economy, represented by the trade balance, the current account, and consumption allocations and the financial side, such as portfolio holdings, stock prices and valuation changes. Methodologically, we contribute to the existing DSGE literature on international portfolio choice that so far has either relied on approximation methods or used simplified asset market structures.

Keywords: Current account, portfolio rebalancing, capital gains, international finance, asset pricing, global imbalances

JEL Classification: G12, G15, F31, F36

Suggested Citation

Pavlova, Anna and Rigobon, Roberto, Equilibrium Portfolios and External Adjustment Under Incomplete Markets (March 27, 2012). AFA 2009 San Francisco Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1107477 or http://dx.doi.org/10.2139/ssrn.1107477

Anna Pavlova (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 20 7000 8218 (Phone)

HOME PAGE: http://faculty.london.edu/apavlova

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-447
Cambridge, MA 02142
United States
617-258-8374 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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