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Why are countries’ asset portfolios exposed to nominal exchange rates?

Jonathan Adams and Philip Barrett

Journal of International Money and Finance, 2021, vol. 110, issue C

Abstract: Most countries hold large gross asset positions, lending in their domestic currency and borrowing in foreign currency. As a result, their balance sheets are exposed to nominal exchange rate movements. We argue that when asset markets are incomplete, this exposure provides partial insurance against shocks that move exchange rates. We demonstrate that this insurance motive can simultaneously generate realistic gross asset positions and resolve the Backus-Smith puzzle: that countries’ relative consumption and real exchange rates are negatively correlated. Local perturbation methods are inaccurate in this setting as they approximate around the wrong interest rate, even when they correctly characterize the average portfolio holdings. So to accurately solve the equilibrium portfolio problem, we extend Maliar and Maliar (2015)’s global projection method.

Keywords: Country portfolios; International business cycles; Home bias; Gross asset positions; Exchange rates; Backus-Smith puzzle (search for similar items in EconPapers)
JEL-codes: F30 F41 (search for similar items in EconPapers)
Date: 2021
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Working Paper: Why are Countries’ Asset Portfolios Exposed to Nominal Exchange Rates? (2017) Downloads
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DOI: 10.1016/j.jimonfin.2020.102277

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