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Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds

54 Pages Posted: 22 Apr 2011  

Filipa Sa

King's College London; IZA Institute of Labor Economics

Francesca Viani

Banco de España

Multiple version iconThere are 3 versions of this paper

Date Written: April 18, 2011

Abstract

Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterised by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the consequences of an increase in the importance of sovereign wealth funds (SWFs). Specifically, we ask what would happen if ‘excess’ reserves held by emerging markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the ‘exorbitant privilege’, ie, the excess return the United States receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.

Keywords: Portfolio preferences, sudden stops, imperfect substitutability, global imbalances, sovereign wealth fund

JEL Classification: F32

Suggested Citation

Sa, Filipa and Viani, Francesca, Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds (April 18, 2011). Bank of England Working Paper No. 423. Available at SSRN: https://ssrn.com/abstract=1814988 or http://dx.doi.org/10.2139/ssrn.1814988

Filipa G. Sa (Contact Author)

King's College London ( email )

150 Stamford Street
London, SE1 9NN
United Kingdom

IZA Institute of Labor Economics

Schaumburg-Lippe-Str. 7 / 9
Bonn, D-53072
Germany

Francesca Viani

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

HOME PAGE: http://www.bde.es

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