Portfolio Choice and Partial Default in Emerging Markets: a quantitative analysis

Kieran Walsh
Additional contact information
Kieran Walsh: Yale

No 789, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: What are the determinants and economic consequences of cross-border asset positions? I develop a new quantitative portfolio choice model and apply it to emerging market international finance. The model allows for partial default and accommodates trade in a rich set of assets. The latter means I am able to draw distinctions both between debt and equity finance and between gross and net debt. The main contribution is in developing portfolio choice techniques to analyze capital flows and default in an international finance context. I calibrate the pricing kernel of the model to match properties of U.S. stock returns and yield curves. I then analyze optimal emerging market portfolio and default behavior in response to realistic international financial fluctuations. My calibrated model jointly captures four empirical regularities that have been difficult to produce in the quantitative international finance literature: (1) Gross capital inflow and outflow are pro-cyclical. My model generates this as well as pro-cyclicality in equity liabilities and short-term debt. This is important because recent empirical work emphasizes that the level and composition of gross capital flows are at least as important as current accounts in understanding risk and predicting crises. (2) Most external defaults are partial. (3) Levels of gross external debt in excess of 50% of GNI are common. (4) Usually, borrowers default in bad economic times. Additionally, I provide novel characterizations for stochastic, infinite horizon portfolio problems with partial default. These results allow me to rapidly compute the consumption/portfolio problem solution, even with many assets and default, and they yield two key propositions: (i) for any degree of growth persistence, default increases as market conditions deteriorate, consistent with Regularity (4), and (ii) debt increases with the maturity length of bonds.

Date: 2014
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://red-files-public.s3.amazonaws.com/meetpapers/2014/paper_789.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:789

Access Statistics for this paper

More papers in 2014 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
Bibliographic data for series maintained by Christian Zimmermann ().