The Valuation Channel of External Adjustment

52 Pages Posted: 3 Mar 2010

See all articles by Fabio Pietro Ghironi

Fabio Pietro Ghironi

University of Washington

Jaewoo Lee

International Monetary Fund (IMF) - Research Department

Alessandro Rebucci

Johns Hopkins University - Carey Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: December 22, 2009

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.

Keywords: current account, equity, net foreign assets, risk sharing, valuation

JEL Classification: F32, F41, G11, G15

Suggested Citation

Ghironi, Fabio Pietro and Lee, Jaewoo and Rebucci, Alessandro, The Valuation Channel of External Adjustment (December 22, 2009). FRB of Boston Working Paper No. 09-18. Available at SSRN: https://ssrn.com/abstract=1559369 or http://dx.doi.org/10.2139/ssrn.1559369

Fabio Pietro Ghironi (Contact Author)

University of Washington ( email )

Department of Economics
Box 353330
Seattle, WA 98195-3330
United States
206-543-5795 (Phone)

HOME PAGE: http://faculty.washington.edu/ghiro

Jaewoo Lee

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-7331 (Phone)
202-623-6334 (Fax)

Alessandro Rebucci

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

HOME PAGE: http://carey.jhu.edu/faculty-research/faculty-directory/alessandro-rebucci-phd

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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