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on International Finance |
| By: | Tarek A. Hassan; Thomas M. Mertens; Jingye Wang |
| Abstract: | Standard asset pricing models reconcile high equity premia with smooth risk-free rates by inducing an inverse functional relationship between the mean and the variance of the stochastic discount factor. This highly successful resolution to closed-economy asset pricing puzzles is fundamentally problematic when applied to open economies: It requires that differences in currency returns arise almost exclusively from predictable appreciations, not from interest rate differentials. In the data, by contrast, exchange rates are largely unpredictable, and currency returns arise from persistent interest rate differentials. We show currency risk premia arising in canonical long-run risk and habit preferences cannot match this fact. We argue this tension between canonical asset pricing and international macroeconomic models is a key reason researchers have struggled to reconcile the observed behavior of exchange rates, interest rates, and capital flows across countries. The lack of such a unifying model is a major impediment to understanding the effect of risk premia on international markets. |
| Keywords: | currency premium; asset pricing; macroeconomic models; exchange rates; interest rates; international capital flows |
| Date: | 2024–10–18 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedfwp:99017 |
| By: | Rodolfo G. Campos (BANCO DE ESPAÑA); Ana-Simona Manu (EUROPEAN CENTRAL BANK); Luis Molina (BANCO DE ESPAÑA); Marta Suárez-Varela (BANCO DE ESPAÑA) |
| Abstract: | This paper analyzes the financial spillovers of shocks originating in China to emerging markets. Using a high-frequency identification strategy based on sign and narrative restrictions, we find that equity markets react strongly and persistently to Chinese macroeconomic shocks, while monetary policy shocks have limited or no spillovers. The impact is particularly strong in Latin American equity markets, with the likely channel being the effect of shocks in China on international commodity prices. These effects extend to various financial variables, such as sovereign and corporate spreads and exchange rates, suggesting that macroeconomic shocks in China may have implications for economic cycles and financial stability in emerging markets. |
| Keywords: | China, emerging markets, financial spillovers |
| JEL: | F31 F37 F62 F65 G15 N26 |
| Date: | 2024–10 |
| URL: | https://d.repec.org/n?u=RePEc:bde:wpaper:2435 |
| By: | Pellegrino, Bruno; Spolaore, Enrico; Wacziarg, Romain |
| Abstract: | Observed international investment positions and cross-country heterogeneity in rates of return to capital are hard to reconcile with frictionless capital markets. In this paper, we develop a theory of international capital allocation: a multi-country dynamic spatial general equilibrium model in which the entire network of cross-border investment is endogenously determined. Our model features cross-country heterogeneity in fundamental risk, a demand system for international assets, and frictions that cause segmentation in international capital markets. We measure frictions affecting international investment and apply our model to data from nearly 100 countries, using a new dataset of international capital taxes and cultural, geographic and linguistic distances between countries (geopoliticaldistance.org). Our model performs well in reproducing the composition of international portfolios, the cross-section of home bias and rates of return to capital, and other key features of international capital markets. Finally, we carry out counterfactual exercises: we show that barriers to international investment reduce world output by almost 7% and account for nearly half of the observed cross-country differences in capital stock per employee. |
| Keywords: | Capital Allocation, Cultural Distance, Geography, Information Frictions, International Finance, International Investment, Misallocation, Open Economy, Rational Inattention |
| JEL: | E22 E44 F2 F3 F4 G15 O4 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:cbscwp:303525 |
| By: | Jocelyn Boussard; Chiara Castrovillari; Tomohide Mineyama; Marta Spinella; Bilal Tabti; Maxwell Tuuli |
| Abstract: | This paper investigates the consequences of global shocks on a sample of low- and lower-middle-income countries with a particular focus on fragile and conflict-affected states (FCS). FCS are a group of countries that display institutional weakness and/or are negatively affected by active conflict, thereby facing challenges in macroeconomic policy management. Examining different global shocks associated with commodity prices, external demand, and financing conditions, this paper establishes that FCS economies are more vulnerable to these shocks compared to non-FCS peers. The higher sensitivity of FCS economies is mainly driven by procyclical fiscal responses, aggravated by the lack of effective spending controls and timely access to financial sources. External financing serves as a source of stability, partially mitigating the adverse impact of global shocks. This paper contributes to a better understanding of how conditions of fragility, which are on the rise in many parts of the world today, can amplify the effects of negative exogenous shocks. Its results highlight the diverse nature of underlying sources of vulnerabilities, spanning from fiscal and external buffers to institutional quality and economic structure, with lessons applicable to a broader set of countries. Efficient and timely external financial support from external partners, including international financial institutions, should help countries’ counter-cyclical responses to mitigate adverse shocks and achieve macroeconomic stability. |
| Keywords: | Global shocks; external financing; low-income countries; Fragile and conflict-affected states (FCS) |
| Date: | 2024–10–04 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/214 |