The Risk Premium and Long-Run Global Imbalances

YiLi Chien and Kanda Naknoi

Purdue University Economics Working Papers from Purdue University, Department of Economics

Abstract: Our paper investigates whether the valuation effect caused by a large risk premium and a low risk-free rate can help to explain the enormous US current account and trade deficit observed in the past decade. To answer this question, we set up an endowment growth model in which investors are endowed with heterogeneous trading technologies. In our model, the average US investors load up more aggregate risk by investing in a risky asset abroad and issuing a risk-free asset. Thanks to the large risk premium as well as the low risk-free rate, the US can sustain a long-run trade deficit even as a debtor country. Quantitatively, we find that the valuation effect caused solely by the high risk premium and the low risk-free rate in our model, which is calibrated to match the external assets and liabilities of US economy, can account for more than half of the observed trade deficit and current account deficit. Our results suggest that the current US trade deficit might not necessarily lead to net export increases or dollar depreciation in the future.

Keywords: Global Imbalances; External Account; Risk Premium; Asset Pricing; Limited Participation (search for similar items in EconPapers)
JEL-codes: E21 F32 F41 G12 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2011-10
New Economics Papers: this item is included in nep-ifn, nep-mac, nep-opm and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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https://business.purdue.edu/research/Working-papers-series/2011/1266.pdf (application/pdf)

Related works:
Journal Article: The risk premium and long-run global imbalances (2015)
Working Paper: The Risk Premium and Long-Run Global Imbalances (2013)
Working Paper: The risk premium and long-run global imbalances (2012)
Working Paper: The Risk Premium and Long-Run Global Imbalances (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:pur:prukra:1266

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