country portfolios under global imbalances abstract this paper studies the composition of country portfolios under global imbalances when countries are identical the optimal portfolio is fully diversified which reflects the cross country symmetric self hedging lucas 1982 assuming a structural country asymmetry in patience we construct a model of portfolio choices that features persistent non zero net foreign assets nfa because the latter opens a gap between gnp and gdp we found that an asymmetric hedging of net portfolio returns emerges in addition to the otherwise only lucas symmetric self hedging in shaping the gross country portfolios which implies a short long position of the local asset in the debtor creditor country the resulting portfolio is home biased we calibrate our model to the u s and china data over 1999 2017 and show that it matches the portfolio data for countries with unbalanced net external positions well

a method for solving general equilibrium models with incomplete markets and many financial assets abstract this paper presents a numerical method for solving stochastic general equilibrium models with dynamic portfolio choice the method can be applied to models with heterogeneous agents time varying investment opportunity sets and incomplete asset markets we illustrate the method using a two country model with production we check the accuracy of our method by comparing the numerical solution to a complete markets version of the model against its known analytic properties we then apply the method to an incomplete markets version where no analytic solution is available in all versions the standard accuracy tests confirm the effectiveness of our method

calculating and using second order accurate solutions of discrete time dynamic equilibrium models we describe an algorithm for calculating second order approximations to the solutions to nonlinear stochastic rational expectations models the paper also explains methods for using such an approximate solution to generate forecasts simulated time paths for the model and evaluations of expected welfare differences across different versions of a model the paper gives conditions for local validity of the approximation that allow for disturbance distributions with unbounded support and allow for non stationarity of the solution process

an equilibrium model of incentive contracts in the presence of information manipulation abstract this paper develops an agency model in which stock based compensation is a double edged sword inducing managers to exert productive effort but also to divert valuable firm resources to misrepresent performance we examine how the potential for manipulation affects the equilibrium level of pay for performance sensitivity and derive several new cross sectional implications that are consistent with recent empirical studies in addition we analyze the impact of recent regulatory changes contained in the sarbanes oxley act of 2002 and show how policies intended to increase firm value by reducing misrepresentation can actually reduce firm value or increase the upward bias in manipulated disclosures

capital controls capital flow contractions and macroeconomic vulnerability abstract in this paper i analyze whether restrictions to capital mobility reduce vulnerability to external shocks more specifically i ask if countries that restrict the free flow of international capital have a lower probability of experiencing a large contraction in net capital flows i use three new indexes on the degree of international financial integration and a large multi country data set for 1970 2004 to estimate a series of random effect probit equations i find that the marginal effect of higher capital mobility on the probability of a capital flow contraction is positive and statistically significant but very small having a flexible exchange rate greatly reduces the probability of experiencing a capital flow contraction the benefits of flexible rates increase as the degree of capital mobility increases a higher current account deficit increases the probability of a capital flow contraction while a higher ratio of fdi to gdp reduces that probability

external balances trade and financial conditions abstract i present a new model for the u s external position that accounts for the accumulation of international debt over the past 60 years the model is based on the present value restriction that links a country s external position to future trade flows and financial conditions in the absence of arbitrage opportunities and ponzi schemes it features the role played by the stochastic discount factor the trade and valuation adjustment channels and provides a decomposition of the u s external position into secular and cyclical components the model shows that shocks operating via the valuation channel are the dominant drivers of cyclical dynamics accounting for approximately 80 of the variance over the 60 year sample this channel works primarily via capital gains and losses on u s foreign assets and is closely tied to the international value of the u s dollar in contrast there is no evidence that valuation channel adjustments contribute to the secular dynamics but differences between the average returns on foreign assets and liabilities raise the steady state debt to gdp ratio from approximately 12 to 15 the long term deterioration in the u s position represents a move towards the steady state before the early 1990s and a move away from the steady state thereafter i quantify the expected improvement in future u s trade balances needed to justify this as a sustainable path and show that they are very different from its actual behavior during the last 60 years i also study the behavior of the u s position during the 2007 2008 financial crisis

competition risk and managerial incentives this paper examines how the degree of competition among firms in an industry affects the optimal incentives that firms provide to their managers a central assumption is that there is free entry and exit in the industry which implies that changes in the nature of competition lead to changes in the equilibrium market structure the main result is that as the intensity of product market competition increases as a result of greater product substitutability or greater market size principals unambiguously provide stronger incentives to their agents to reduce costs at the same time more intense competition also leads to more volatile firm level profits consequently managers incentives are positively correlated with firm level risk consistent with empirical evidence a decrease in the cost of entering the market has the opposite effect on incentives but still induces a positive correlation between risk and incentives

a new perspective on the new rule of the current account abstract in an influential series of contributions kraay and ventura 2000 2003 offer a new rule for the current account in response to a temporary income shock the change in the current account is equal to the change in saving times the ratio of net foreign assets to wealth we analyze the impact of a temporary income shock on the current account in the context of a two country dynamic general equilibrium model of portfolio choice and show that the new rule does not hold we also show that the cross section evidence reported by kraay and ventura in favor of the new rule is a feature implied by the steady state of the model that is conceptually distinct from the new rule we argue that the new rule could only hold in a model with one way capital flows only inflows or outflows but not both a feature that is strongly counterfactual

international business cycles and financial frictions abstract in this study i build a two country dsge model to investigate the impact of financial integration on business cycle co movements with financial frictions in this model the investor can borrow but faces a collateral constraint that is tied to the value of her capital and real estate holdings i show quantitatively that the degree of financial integration and real exchange rate adjustment are important for understanding business cycle synchronization under different types of shocks with the technology shock greater financial integration leads to lower cross country correlations while with the financial shock greater financial integration leads to stronger cross country correlations these findings are consistent with the empirical evidence from the literature

product market competition incentives and fraudulent behavior abstract the present paper studies incentive provision in a model where a manager can affect the firm s stock price by exerting unobservable effort and through costly deceptive signalling and investigates the role product market competition plays in shaping shareholders trade off between inducing effort and fraud

financial integration and the wealth effect of exchange rate fluctuations abstract recent years have witnessed a large increase in international financial integration in the form of largely offsetting cross holdings across countries we assess how such financial leverage affects the international transmission of monetary shocks and find that it leads to sizable welfare differentials that far exceed the impact due to nominal rigidities we document the relevance of the exact nature of holdings with bond holdings associated with larger effects than equity holdings the impact of financial leverage on welfare is also sensitive to the extent of exchange rate pass through and the substitutability between goods produced in different countries

asset pledgeability and international transmission of financial shocks abstract this paper studies the international transmission of pledgeability shocks as the recent crisis involved a negative shock to the pledgeability of assets the paper develops a two country portfolio model with leveraged investors that incorporates this type of shock and a solution approach for the corresponding portfolio choice problem this approach captures the effect of pledgeability on asset risk premiums the paper finds that the equilibrium portfolios play a heightened role as transmission channels moreover by complementing the effect of productivity shocks under borrowing constraints the pledgeability shocks improve the fit of an otherwise standard international macroeconomic model for the g7 countries especially during crises

external balances trade flows and financial conditions abstract this paper studies how changing expectations concerning future trade and financial conditions are reflected in international external positions in the absence of ponzi schemes and arbitrage opportunities the net foreign asset position of any country must as a matter of theory equal the expected present discounted value of future trade deficits discounted at the cumulated world stochastic discount factor sdf that prices all freely traded financial assets i study the forecasting implications of this theoretical link in 12 countries australia canada china france germany india italy japan south korea thailand the united states and the united kingdom between 1970 and 2011 i find that variations in the external positions of most countries reflect changing expectations about trade conditions far into the future i also find the changing forecasts for the future path of the world sdf are reflected in the dynamics of the u s external position

a two period model with portfolio choice understanding results from different solution methods using a stylized two period model we compare portfolio solutions from two local solution approaches the approach of judd and guu 2001 and the approach of devereux and sutherland 2010 2011 with the true nonlinear portfolio solution

composition and growth effects of the current account a synthesized portfolio view abstract this paper analyzes a useful accounting framework that breaks down the current account to two components a composition effect and a growth effect we show that past empirical evidence which strongly supports the growth effect as the main driver of current account dynamics is misconceived the remarkable empirical success of the growth effect is driven by the dominance of the cross sectional variation which under conditions met by the data is generated by an accounting approximation in contrast to previous findings that the portfolio share of net foreign assets to total assets is constant in a country both our theoretical and empirical results support a highly persistent process or a unit root process with some countries displaying a trend finally we reestablish the composition effect as the quantitatively dominant driving force of current account dynamics in the past data

do trade costs in goods market lead to home bias in equities abstract two of the main puzzles in international economics are the consumption and the portfolio home biases we solve for international equity portfolios in a two country two good stochastic equilibrium model with trade costs in goods markets we show that introducing trade costs as suggested by obstfeld and rogoff obstfeld m rogoff k 2000a the six major puzzles in international macroeconomics is there a common cause nber macroeconomics annual 15 is not sufficient to explain these two puzzles simultaneously on the contrary we find that trade costs create a foreign bias in portfolios for reasonable parameter values this result is robust to the addition of non tradable goods for standard calibrations of the preferences

home bias and high turnover dynamic portfolio choice with incomplete markets why do investors trade a lot in foreign assets and hold so little of them in their portfolios this paper shows that both observations can arise naturally in the presence of nondiversifiable nontraded consumption risk when each country specializes in production preferences exhibit consumption home bias and asset markets are incomplete using a general equilibrium two country two sector tradable and nontradable model of the world economy with production i show that low diversification occurs because variations in relative prices i increase the riskiness of foreign assets and ii facilitate risk sharing across countries large and volatile capital flows are necessary to take advantage of international risk premia differentials that occur in response to productivity changes in the nontradable sector i characterize the optimal portfolio holdings the evolution of the investment opportunity set the risk premium and the dynamics of capital flows using a new methodology for solving dynamic general equilibrium models with incomplete markets and portfolio choice

risk external adjustment and capital flows abstract this paper studies the process of external adjustment i develop an open economy model with endowment and preference shocks that can account for the empirical behavior of real exchange rates interest rates and consumption in the u s and europe the model includes cross border holdings of bonds and equity and financial frictions that impede international risk sharing i find that external adjustment following endowment shocks predominantly takes place via trade flows consistent with the intertemporal approach to the current account in contrast preference shocks that change investors risk aversion induce adjustment via the trade and valuation channels where the latter includes the effects of unexpected capital gains and loss on existing cross border holdings and changes in the expected future return differentials between foreign assets and liabilities the model estimates imply that the valuation channel of external adjustment is more important for the u s than the trade channel consistent with this implication i show that forecasts of future return differentials contributed most to the volatility of the u s net foreign asset position in the post bretton woods era

optimal currency diversification for a class of risk averse international investors abstract in the framework of continuous time finance theory this paper derives the dynamic optimal consumption and portfolio rules for a risk averse international investor who consumes in fixed proportions goods produced in n different countries and holds the respective n currencies restricting the processes generating n currency prices and exchange rates to follow brownian motion optimal portfolios of eight major currencies are presented showing substantial departures from the expenditure shares and from purchasing power parity thus even under infinite risk aversion investors consuming only one good would hold a diversified currency portfolio

the economics of earnings manipulation and managerial compensation this article examines managerial compensation in an environment where managers may take a hidden action that affects the actual earnings of the firm when realized these earnings constitute hidden information that is privately observed by the manager who may expend resources to generate an inflated earnings report we characterize the optimal managerial compensation contract in this setting and demonstrate that contracts contingent on reported earnings cannot provide managers with the incentive both to maximize profits and to report those profits honestly as a result some degree of earnings management must be tolerated as a necessary part of an efficient agreement

cross border returns differentials were the u s to persistently earn substantially more on its foreign investments u s claims than foreigners earn on their u s investments u s liabilities the likelihood that the current environment of sizeable global imbalances will evolve in a benign manner increases however we find that the returns differential of u s claims over u s liabilities is far smaller than previously reported and importantly is near zero for portfolio equity and debt securities for portfolio securities we confirm our finding using a separate dataset on the actual foreign equity and bond portfolios of u s investors and the u s equity and bond portfolios of foreign investors in the context of equity and bond portfolios we find no evidence that the u s can count on earning more on its claims than it pays on its liabilities finally we reconcile our finding of a near zero returns differential with observed patterns of cumulated current account deficits the net international investment position and the net income balance jel codes f3

computing second order accurate solutions for rational expectation models using linear solution methods this paper shows how to compute a second order accurate solution of a non linear rational expectation model using algorithms developed for the solution of linear rational expectation models the result is a state space representation for the realized values of the variables of the model this statespace representation can easily be used to compute impulse responses as well as conditional and unconditional forecasts

globalization and the increasing correlation between capital inflows and outflows abstract the correlation between capital inflows and outflows has increased substantially over time in a sample of 127 advanced and developing countries we provide evidence that this is a result of an increase in financial globalization stock of external assets and liabilities this dominates the effect of an increase in trade globalization exports plus imports which reduces the correlation between capital inflows and outflows in the context of a two country model with 8 shocks we show that the theoretical impact of financial and trade globalization on the correlation between capital inflows and outflows is consistent with the data

the impact of performance based compensation on misreporting abstract this paper examines the effect of ceo compensation contracts on misreporting we find that the sensitivity of the ceo s option portfolio to stock price is significantly positively related to the propensity to misreport we do not find that the sensitivity of other components of ceo compensation i e equity restricted stock long term incentive payouts and salary plus bonus have any significant impact on the propensity to misreport relative to other components of compensation stock options are associated with stronger incentives to misreport because convexity in ceo wealth introduced by stock options limits the downside risk on detection of the misreporting

international capital flows abstract the surge in international asset trade since the early 1990s has lead to renewed interest in models with international portfolio choice we develop the implications of portfolio choice for both gross and net international capital flows in the context of a simple two country dynamic stochastic general equilibrium dsge model we focus on the time variation in portfolio allocation following shocks and resulting capital flows endogenous time variation in expected returns and risk which are the key determinants of portfolio choice affect capital flows in often subtle ways the model is consistent with a broad range of empirical evidence an additional contribution of the paper is to overcome the technical difficulty of solving dsge models with portfolio choice by developing a broadly applicable solution method

financial integration macroeconomic volatility and welfare this paper studies the effects of financial integration on macroeconomic volatility and welfare we examine a two sector tradable and nontradable twocountry world economy with production in which both stocks and bonds are traded internationally but markets are incomplete the effects of integration are examined by comparing the equilibrium properties of the model under three financial configurations autarky low integration and high integration the model predicts a non monotonic relationship between the degree of financial integration and the volatility of several macroeconomic variables greater integration is initially associated with more volatile consumption and output but as integration proceeds further volatility declines we also find that while increased integration allows for significantly greater risk sharing between countries the improvement in welfare can be very small

the risk premium and long run global imbalances this study proposes that heterogeneous household portfolio choices within a country and across countries offer an explanation for global imbalances we construct a stochastic growth multi country model in which heterogeneous agents face the following restrictions on asset trade first the degree of us equity market participation is higher than that of the rest of the world second a fraction of households in each country maintains a fixed share of equity in its portfolios in our calibrated model which matches the us net foreign asset position and the equity premium the average us household loads up more aggregate risk than the average foreign household by investing in risky assets abroad and issuing risk free assets as a result the us is compensated by a high risk premium and runs trade deficits even as a debtor country the long run average trade deficit in our model accounts for 50 of the observed us trade deficit

evolution of bilateral capital flows to developing countries at intensive and extensive margins motivated by the rise in capital flows to low income countries lics we examine the nature of these flows and the factors affecting foreign investors decision recognizing the presence of fixed investment costs we analyze capital flows at both intensive and extensive margins to fix ideas we resort to the gravity literature for the estimating relationships which we embed into a two tier econometric framework with cross sectional dependence our main finding is that market entry costs are statistically and economically very detrimental to lics we also obtain the gravity type relationship for the destination income unconditionally but not after conditioning on relevant variables as well as establish labor productivity as a robust attractor of capital inflows

discussion on gross capital flows dynamics and crises by broner didier erce and schmukler international capital flows have always been an important topic in international economics capital flows help a country exploit better investment opportunity and smooth consumption over the past few years global current account imbalances have been at the forefront of policy debates large amount of research devotes to the study of net capital flows while fewer works put their focus on gross capital flows this paper fills the gap this paper provides a systematic analysis over business cycle behavior of gross capital flows it looks at 103 countries between 1970 and 2009 the countries are divided into three groups lower middler income upper middler income and high income countries three forms of capital flows are examined direct investment portfolio and other investments to study impact of crisis over gross capital flows it also classifies financial crisis into different types banking crisis currency crisis and domestic debt and external debt crisis the paper has the following key findings first both gross capital inflows and outflows increase relative to gdp trend over period of time second gross flows are larger and more volatile than net flows third gross inflows and outflows are positively correlated especially for high income countries lastly both inflows and outflows are procyclical and shrink during crises decline of capital flows during crises is observed in all forms direct investment portfolio and other investments broner et al raise a new challenge for the international literature standard international real business cycle model as in backus et al 1992 mostly has one asset and cannot address issues related to global capital flows this paper calls for a unified theory to model gross capital flows and to account for the key findings in this paper one candidate is the literature on portfolio choices this literature mainly focuses on long run composition of portfolios the so called home bias puzzle in asset french and poterba 1991 first pointed out american held roughly 94 of their equity wealth in the us stock market heathcote and fabrizio 2007 give a review over the findings in this literature two exceptions hnatkovska 2010 and tille and wincoop 2010 study cyclicality of gross capital flows their models however generate counterfactual capital flows as pointed out by broner et al in this discussion i focus on new theories that have the potential to explain co movement of capital inflows and outflows

three laws of energy transitions the paper formulates and explores a hypothesis on three general energy transition laws the law of stable long term energy costs to income ratio the law of improving energy quality and the law of growing energy productivity these laws are essential for shaping long term projections and checking for their consistency all three are rooted in amazingly stable in time and universal across countries energy costs to income ratios limited energy purchasing power sets up thresholds which if exceeded bring asymmetry to energy demand to price elasticity the author believes that the theoretical postulate on the substantial substitution among production factors which is used in the production functions theory may be incorrect in reality innovations mainly lead to the substitution of a low quality production factor with the same yet of a better quality improving energy quality with stable costs to income ratio is accompanied by growing energy productivity energy costs to income thresholds are indicators allowing for better projections of oil prices

current accounts in debtor and creditor countries the authors reexamine a classic question in international economics what is the current account response to a transitory income shock such as a temporary improvement in the terms of trade a transfer from abroad or unusually high production to answer this question they construct a world equilibrium model in which productivity varies across countries and international borrowing and lending take place to exploit good investment opportunities despite its conventional ingredients the model generates the novel prediction that favorable income shocks lead to current account deficits in debtor countries and current account surpluses in creditor countries evidence from thirteen oecd countries broadly supports this theoretical prediction

country portfolios in open economy macro models this paper develops a simple approximation method for computing equilibrium portfolios in dynamic general equilibrium open economy macro models the method is widely applicable simple to implement and gives analytical solutions for equilibrium portfolio positions in any combination or types of asset it can be used in models with any number of assets whether markets are complete or incomplete and can be applied to stochastic dynamic general equilibrium models of any dimension so long as the model is amenable to a solution using standard approximation methods we first illustrate the approach using a simple two asset endowment economy model and then show how the results extend to the case of any number of assets and general economic structure

on the theory of international currency portfolios abstract the paper develops a general equilibrium theory of the optimal currency composition of international bond portfolios like the partial equilibrium portfolio balance literature of the 1980s the theory emphasizes the critical roles of government debt and government balance sheet operations in the determination of portfolios prices and allocations consistent with empirical findings optimal foreign currency positions are found to be small with their size decreasing with exchange rate volatility while optimal domestic currency positions are large and increasing with domestic interest rates a large open market purchase of domestic currency bonds from private households lowers domestic interest rates