International Capital Flows

FRB of New York Staff Report No. 280

HKIMR Working Paper No. 12/2007

44 Pages Posted: 18 Apr 2007

See all articles by Cédric Tille

Cédric Tille

Graduate Institute of International and Development Studies (HEI)

Eric van Wincoop

University of Virginia - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: June 2007

Abstract

The sharp increase in both gross and net capital flows over the past two decades has led to a renewed interest in their determinants. Most existing theories of international capital flows are in the context of models with only one asset, which only have implications for net capital flows, not gross flows. Moreover, there is no role for capital flows as a result of changing expected returns and risk-characteristics of assets as there is no portfolio choice. In this paper we develop a method for solving dynamic stochastic general equilibrium open-economy models with portfolio choice. We show why standard first- and second-order solution methods no longer work in the presence of portfolio choice, and extend them giving special treatment to the optimality conditions for portfolio choice. We apply the solution method to a particular two-country, two-good, two-asset model and show that it leads to a much richer understanding of both gross and net capital flows. The approach highlights time-varying portfolio shares, resulting from time-varying expected returns and risk characteristics of the assets, as a potential key source of international capital flows.

Keywords: international capital flows, portfolio allocation, home bias

JEL Classification: F32, F36, F41

Suggested Citation

Tille, Cedric and van Wincoop, Eric, International Capital Flows (June 2007). FRB of New York Staff Report No. 280; HKIMR Working Paper No. 12/2007. Available at SSRN: https://ssrn.com/abstract=980770 or http://dx.doi.org/10.2139/ssrn.980770

Cedric Tille (Contact Author)

Graduate Institute of International and Development Studies (HEI) ( email )

PO Box 136
Geneva, CH-1211
Switzerland

HOME PAGE: http://sites.google.com/site/cedrictilleheid/home

Eric Van Wincoop

University of Virginia - Department of Economics ( email )

Rouss Hall 114
P.O. Box 400182
Charlottesville, VA 22904-4182
United States
804-924-3997 (Phone)
804-982-2904 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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