The Valuation Channel of International Adjustment
By
F. Ghironi, J. Lee, and A. Rebucci
The views expressed are those of the discussant and not those of the IDB or its Executive Board.
Risk Sharing Conference, October 22-23, 2010
Motivation• The relative importance, working, and risk
sharing role of the “financial channel” of external adjustment (GR, 2007) are the subject of an ongoing policy and academic debate
• Changes in NFA can arise from:– changes in quantities and prices of goods
and services: the "trade" channel of adjustment
– or changes in asset prices and returns: the "financial" channel of adjustment.
This paper• Focuses on the pure “capital gain and
loss” component of the of the financial channel of adjustment– Consistent with statistical practices and
data availability
It makes three points:
• The predictable component of valuation effects can be modeled without resorting to higher order approximations of the portfolio decision
• This component is non-negligible in NFA dynamics, although its risk sharing role is difficult to isolate
• The source of the shock triggering external adjustment matters
Outline
• Model overview• Decomposing NFA• Key result• Robustness• Other results• Conclusions
Model overview• Standard, symmetric, two-country, DSGE portfolio model with:– International trade in equity– No transaction costs (results in early
analysis robust)– Production under monopolistic competition
(endogenous labor) and flex prices– Productivity and government shocks (asset
markets are incomplete)– No trade frictions: LOP and PPP hold and no
role for RER
Budget constraint and NFA definition
Decomposing first-order changes in NFA (Solution details skipped)
Decomposing NFA (Cont.)
Valuation effects in response to productivity shocks are predictable
Relative importance of CA and Val
Intuition
Comparison with literature
Robustness• Persistent shocks (DS, 2009)
– When the shocks are permanent, CA does not move: the predictable component of Val is zero and the two definitions coincide (see Nguyen, 2009 for more discussion)
• In NPV terms, they are irrelevant for sustainability perspective (TvW, 2008):– True, but their time profile may matter in
practice (i.e., illiquidity may lead to insolvency as in some emerging market crisis of the past)
Differences
Other results• Government shocks don’t give rise to
predictable valuation effects in our simple model– Interesting to investigate relative role of
different shocks under alternative model structures
• Role for risk sharing: valuation effects are
a channel of risk sharing in the model. – Any quantification is model-dependent– More interesting to investigate this in the
data from the lenses of a particular model
Conclusions
Thank you