Nominal Exchange Rates and Net Foreign Assets' Dynamics: the Stabilization Role of Valuation Effects

Sara Eugeni

MPRA Paper from University Library of Munich, Germany

Abstract: Recent empirical studies have highlighted that valuation effects associated with fluctuations of nominal exchange rates are one of the key components that drive the behaviour of the net foreign assets position of a country. In this paper, we propose a two-country overlapping-generations model of nominal exchange rate determination with endogenous portfolio choice in line with this evidence. We show that a country runs a current account deficit when its share of world GDP decreases. As the domestic currency depreciates in equilibrium, a positive wealth effect partially offsets the current deficit and therefore has a stabilizing impact on the net external position of the country. The model rationalizes the deterioration of the US external position over the past 20 years as a consequence of the rise of emerging market countries in the world economy, while being consistent with the fact the US have experienced positive valuation effects. Numerical results indicate that valuation effects are quantitatively relevant as they account for more than half of the cumulated US current account deficits, consistently with the data.

Keywords: portfolio choice; nominal exchange rates; valuation effects; incomplete markets; two-country OLG model (search for similar items in EconPapers)
JEL-codes: F30 F31 F32 F40 F41 (search for similar items in EconPapers)
Date: 2015-04
New Economics Papers: this item is included in nep-dge and nep-opm
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Related works:
Journal Article: Nominal exchange rates and net foreign assets' dynamics: The stabilization role of valuation effects (2024)
Working Paper: Nominal Exchange Rates and Net Foreign Assets' Dynamics: the Stabilization Role of Valuation Effects (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:63549

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