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A Theory of Gross and Net Capital Flows over the Global Financial Cycle

Jonathan Davis and Eric Van Wincoop

No 410, Globalization Institute Working Papers from Federal Reserve Bank of Dallas

Abstract: We develop a theory to account for changes in gross and net capital flows over the global financial cycle (GFC). The theory relies critically on portfolio heterogeneity among investors within and across countries, related to risky portfolio shares and portfolio shares allocated to foreign assets. A global drop in risky asset prices during a downturn of the GFC changes relative wealth within and across countries due to portfolio heterogeneity. This leads to changes in gross and net capital flows that are consistent with the stylized facts: all countries experience a decline in gross capital flows (retrenchment), while countries that have a net debt of safe assets experience a rise in total net outflows and net outflows of safe assets and a drop in net outflows of risky assets. The model is applied to 20 advanced countries and calibrated to micro data related to within country portfolio heterogeneity, as well as cross country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for gross and net capital flows are quantitatively consistent with the data.

Keywords: Global Financial Cycle; Capital Flows; Current Account; Portfolio Heterogeneity (search for similar items in EconPapers)
JEL-codes: F30 F40 (search for similar items in EconPapers)
Pages: 69
Date: 2021-09-09, Revised 2022-12-20
New Economics Papers: this item is included in nep-ifn, nep-isf and nep-opm
Note: The previous version of the paper circulated with the title "A Theory of the Global Financial Cycle."
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddgw:93046

DOI: 10.24149/gwp410r1

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