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Why are Countries’ Asset Portfolios Exposed to Nominal Exchange Rates?

Jonathan Adams and Philip Barrett

No 2017/291, IMF Working Papers from International Monetary Fund

Abstract: Most countries hold large gross asset positions, lending in domestic currency and borrowing in foreign. Thus, their balance sheets are exposed to nominal exchange rates. We argue that when asset markets are incomplete, nominal exchange rate exposure allows countries to partially insure against shocks that move real exchange rates. We demonstrate that asset market incompleteness can simultaneously generate realistic gross asset positions and resolve the Backus-Smith puzzle: that relative consumptions and real exchange rates correlate negatively. We also show that local perturbation methods that use stabilizing endogenous discount factors are inaccurate when average and steady state interest rates differ. To address this, we develop a novel global solution method to accurately solve the model.

Keywords: WP; exchange rate; Country portfolios; international business cycles; home bias; gross asset positions; exchange rates; Backus-Smith puzzle; asset market incompleteness; Backus-Smith correlation; goods firm; consumption puzzle; interest rate parity; price level; asset dynamics; Real exchange rates; Consumption; Bonds; Securities markets; Global (search for similar items in EconPapers)
Pages: 48
Date: 2017-12-22
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Journal Article: Why are countries’ asset portfolios exposed to nominal exchange rates? (2021) Downloads
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Handle: RePEc:imf:imfwpa:2017/291