International Capital Markets and Wealth Transfers

Magnus Dahlquist, Christian Heyerdahl-Larsen, Anna Pavlova and Julien Penasse

No 17334, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In periods of global stress, there are large movements in exchange rates and asset prices. Currencies of developed economies appreciate, with the US dollar appreciating the most. Global stock markets fall, but the US market falls by less. While the external balance sheet of the US is riskier and its net foreign assets fall, this effect is overturned by the dollar appreciation, resulting in a wealth transfer to the US. To rationalize these facts, we build a general equilibrium model with time-varying risk appetites that produces asymmetric portfolios. Richer countries have more appetite for risk, levering up their external portfolios by borrowing from poorer countries. Consequently, their net foreign assets fall in periods of stress, yet there is a wealth transfer from poor to rich countries due to currency appreciations. The model delivers time-varying currency risk premia, matches key asset pricing moments, and produces realistic external portfolios.

Keywords: Currency risk premium; Habit formation; Net foreign assets; Wealth transfers (search for similar items in EconPapers)
JEL-codes: E43 F31 G12 G15 (search for similar items in EconPapers)
Date: 2022-05
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