International Capital Flows
Cédric Tille () and
Eric van Wincoop ()
No 122007, Working Papers from Hong Kong Institute for Monetary Research
The sharp increase in both gross and net capital flows over the past two decades has led to a renewed interest in their determinants. Most existing theories of international capital flows are in the context of models with only one asset, which only have implications for net capital flows, not gross flows. Moreover, there is no role for capital flows as a result of changing expected returns and risk-characteristics of assets as there is no portfolio choice. In this paper we develop a method for solving dynamic stochastic general equilibrium open-economy models with portfolio choice. We show why standard first- and secondorder solution methods no longer work in the presence of portfolio choice, and extend them giving special treatment to the optimality conditions for portfolio choice. We apply the solution method to a particular two-country, two-good, two-asset model and show that it leads to a much richer understanding of both gross and net capital flows. The approach highlights time-varying portfolio shares, resulting from time-varying expected returns and risk characteristics of the assets, as a potential key source of international capital flows.
Keywords: international capital flows; portfolio allocation; home bias. (search for similar items in EconPapers)
JEL-codes: F32 F36 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-dge and nep-ifn
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Journal Article: International capital flows (2010)
Working Paper: International Capital Flows (2008)
Working Paper: International capital flows (2007)
Working Paper: International Capital Flows (2007)
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