A Model of Chinese Capital Account Liberalisation

HKIMR Working Paper No.12/2013

41 Pages Posted: 19 Aug 2013

See all articles by Dong He

Dong He

Hong Kong Monetary Authority; Hong Kong Institute for Monetary Research (HKIMR)

Paul Luk

Hong Kong Baptist University (HKBU)

Date Written: August 2013


In shaping the evolution of the global financial system in the decade ahead, few events will likely be more significant than capital account liberalisation in China and the internationalisation of the renminbi. This paper provides a theory-based inquiry into the contours of China's international balance sheets after the renminbi becomes convertible under the capital account. We construct a two-country general equilibrium model with trading in equities and bonds and calibrate the model with U.S. and Chinese data. We interpret Chinese capital account liberalisation as a removal of restrictions that prohibit agents from trading Chinese bonds and U.S. equities. We explore how international risk-sharing can be achieved through portfolio diversification in each of these asset market configurations. We also look at how these holdings would change as China gradually re-balances its production with a higher share of labour income, and as the productivity gap between China and the U.S. narrows. We find that both U.S. and Chinese residents would have incentives to increase their holdings in each other's equities, and to issue debt in each other's currency. We interpret the latter observation as the co-existence of the U.S. dollar and the renminbi as major international currencies.

Keywords: China, country portfolios, capital account liberalization, renminbi internationalization

JEL Classification: F3, F4, G1

Suggested Citation

He, Dong and Luk, Paul, A Model of Chinese Capital Account Liberalisation (August 2013). HKIMR Working Paper No.12/2013. Available at SSRN: https://ssrn.com/abstract=2311185 or http://dx.doi.org/10.2139/ssrn.2311185

Dong He

Hong Kong Monetary Authority

3 Garden Road, 30th Floor
Hong Kong
Hong Kong

Hong Kong Institute for Monetary Research (HKIMR)

3 Garden Road, 8th Floor
Hong Kong

Paul Luk (Contact Author)

Hong Kong Baptist University (HKBU) ( email )

Hong Kong

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