Capital Trading,Stock Trading,and the Inflation Tax on Equity

A market for used capital goods, or financial instruments that represent the ownership of the used capital goods, induces inflation taxes on wealth and on the nominal income flows that they provide. This paper explicitly introduces trading in either used capital goods or financial instruments into the standard stochastic growth model with money and production. These two monetary economies are equivalent. The value of the firm is equal to the firm's capital stock divided by inflation. The resulting asset-pricing conditions indicate that the effect of inflation on asset returns differs from the effects found in the literature by the addition of a significant wealth tax. Journal of Economic Literature Classification Numbers: E0, E4, E5.     

A rational expectations model of the U.K. under floating exchange rates

This paper constructs a model of an open economy with both trade and capital flows. Private sector wealth holders are assumed to be concerned with balance sheet ratios as in a portfolio choice theoretic model. Rational expectations in the strict Muth sense is introduced via the asset allocation decision by the private sector. International trade and capital flows are treated as in the monetary theory of the balance of payments. The model is constructed for the U.K. economy and simulation and forecasting exercises are conducted for the floating period.     

International asset market, nonconvergence, and endogenous fluctuations

We develop an overlapping generations model with re-tradeable paper assets and capital accumulation to analyze the interaction between the real economy and an international asset market. The world consists of two homogeneous countries, which differ only in their initial levels of capital. Consumers who live for two periods transfer wealth over time and across countries by holding international mutual funds which pay stochastic dividends. The optimal portfolio decisions of consumers do not necessarily induce convergence of incomes between the two countries. Moreover, interaction through the asset market induces endogenous fluctuation of capital flows between the rich and the poor country.     

ESTIMATES OF HOUSEHOLD SECTOR WEALTH FOR SOUTH AFRICA, 1970–2003

Market values of components of household sector wealth are important explanatory variables for aggregate consumer expenditure and household debt in macro-econometric models. We construct the first coherent set of the main elements of household-sector balance sheet estimates at market value for South Africa. Our quarterly estimates derive from published data on financial flows, and other capital market data, often at book value. Our methods rely, where relevant, on accumulating flow of funds data using appropriate benchmarks, and, where necessary, converting book to market values using appropriate asset price indices. Relating asset to income ratios for various asset classes to asset price movements and other features of the economic environment, throws light on the changing composition of household sector wealth. Most striking are the relative rise in the value of pension wealth and the trend decline of directly held securities, the decline and recent recovery of housing wealth, and the rise in household debt and concomitant decline of liquid assets from the early 1980s to the late 1990s.     

Portfolio Composition Choice: A Behavioral Approach

This experimental study investigates portfolio composition choice for different types of financial assets and different levels of wealth. For a group of financially sophisticated executive MBA students with work experience in capital markets, the findings of this study indicate that the proportion of wealth invested in risky assets increases with wealth for all portfolio compositions examined, and increases with the degree of asset risk. This proportion is found to be as much as three times higher for common stocks than for options: For stock portfolios, it increases from 33% to 44% over the five wealth levels examined, and for options it increases from 11% to 17%. These results may imply a decreasing rel w proportions of their wealth in risky assets possess the following characteristics: they do not invest in options in real life; they sometimes buy lottery tickets; they assign a higher risk level to options than to common stocks; they are female; and they are employed.     

EXTERNAL BALANCE SHEETS: CONCEPTS AND EMPIRICAL APPROXIMATION*

International financial relationships should be interpreted in the context of a comprehensive conceptual framework; this paper advocates the use of concepts developed to measure and analyze balance of payments flows. Broad-based, empirical estimates of the international wealth of most countries of the western world are presented on the basis of cumulating balance of payments flows over a lengthy period. Among the more interesting aspects of the results are: the importance of intra-industrial country capital flows in a global context; the propensity of debtors to regard a larger share of their aggregate external debt as long term than do their creditors; the overwhelming importance of banks located in the industrial countries in global external asset and liability positions, and the preponderance of short-term positions taken by those banks; and the tendency for balance of payments records to report more direct investment assets than liabilities. The paper also contains some observations, based on the cumulations of balance of payments capital flows, concerning the nature and size of certain deficiencies in alternative sources–particularly the World Bank's Debtor Reporting System, and the Bank for International Settlements' banking data–of information on outstanding external debt positions.     

Risk sharing through capital gains

Abstract We estimate channels of international risk sharing between European Monetary Union (EMU), European Union, and other OECD countries, 1992–2007. We focus on risk sharing through savings, factor income flows, and capital gains. Risk sharing through factor income and capital gains was close to zero before 1999 but has increased since then. Risk sharing from capital gains, at about 6%, is higher than risk sharing from factor income flows for European Union countries and OECD countries. Risk sharing from factor income flows is higher for euro zone countries, at 14%, reflecting increased international asset and liability holdings in the euro area.     

The evolution of portfolio rules and the capital asset pricing model

The aim of this paper is to test the performance of capital asset pricing model (CAPM) in an evolutionary framework. We model an economy where a heterogeneous population of long-lived agents invest their wealth according to different portfolio rules, and prove that traders who either “believe” in CAPM and use it as a rule of thumb, or are endowed with genuine mean-variance preferences, under some very weak conditions, vanish in the long run.We show that a sufficient condition to drive CAPM or mean-variance traders’ wealth shares to zero is that an investor endowed with a logarithmic utility function enters the market.     

Optimal diversification and risk-taking: a theoretical and empirical analysis

Among the justifications for capital property income received by private households is that it is a ‘return to risk-taking’. However, portfolio diversification provides an obvious means toward the reduction of risk. Moreover, it is widely believed that the wealthier the household, the more diversification it practices: the larger tends to be the proportion of its total portfolio allocated to publicly traded stock, and the larger tends to be the number of individual stock issues included in its portfolio. Using a simple ‘homogeneous securities’ model, explicit functional forms are obtained for both the optimal proportion of the portfolio allocated to stocks, and the optimal number of individual stock issues in the portfolio. Empirical evaluation of these theoretical results, using a dataset derived from the 2004 Survey of Consumer Finances (SCF), lends substantial support to the model. Applying these empirical results, it is found that as household capital wealth increases, expected capital income increases while simultaneously a reasonable risk indicator (the probability of incurring a negative return on the capital portfolio) decreases owing to the higher level of portfolio diversification. This indication casts significant doubt on the ‘return to risk-taking’ justification for capital property income received by wealthy private households.     

The Consumption/Wealth and Book/Market Ratios in a Dynamic Asset Pricing Contex

This paper addresses new insights into the predictability of financial returns. In particular, we analyze two aspects of the controversial forecasting literature. On the one hand, we demonstrate a positive and contemporaneous link between aggregate book/market and consumption/wealth ratios. On the other hand, we show that real estate and human capital, as the present value of all future salaries, are key components of the consumption/wealth ratio in Spain. Specifically, we find that the cointegrating residuals of consumption, asset holdings, real estate holdings, and our measure of human capital provide a better forecast of future returns than does the standard proxy of the consumption/wealth ratio. This result is important because it clarifies the importance of country-specific components of wealth for cases in which the consumption/wealth ratio is employed as an instrument in conditional asset pricing models.Belén Nieto: Financial support from the Ministerio de Ciencia y Tecnología grant SEJ2005-09372 is gratefully acknowledged.Rosa Rodríguez: Financial support from the Ministerio de Ciencia y Tecnología grant SEC2003-06457 is gratefully acknowledged.     

Global risk and demand for gold by central banks

This article examines the influence of global risk on the holding of gold by central banks based on annual data for 100 countries during 1990–2015. We use a dynamic panel generalized method of moments model to estimate this effect, controlling for a variety of domestic factors. Consistent with portfolio diversification and perception of gold as a safe asset, we find that the gold holdings of central banks increase in response to higher global risk. This effect varies based on the levels of capital account openness, reserve adequacy, income status and currency regimes. These findings suggest that central banks adjust their gold holdings in response to changes in global risk conditions, with the magnitude of response depending on country-specific vulnerabilities.     

Distance and beyond: What drives financial flows to emerging economies?

A major theme in the empirical literature is whether country-specific ‘pull’ or external ‘push’ factors drive international capital flows. In this paper we show that pull-push interactions matter: the response of international investors to country-specific developments depends on global volatility/liquidity stress conditions. We model asset-trade behaviour of investors: with limited information, strong institutional quality ‘pulls’ asset demand; mounting tensions in global markets amplify portfolio adjustments. We derive an empirically testable equation for cross-border bank flows to emerging economies (EMEs) and focus on pull-push interactions that trigger financial vulnerabilities. We find that global volatility amplifies demand for institutional quality, prior to the recent crisis, implying that EMEs with weak institutional settings are exposed to sharp capital retrenchments. In the aftermath of the crisis, the liquidity easing in advanced economies drives down concerns for EMEs' developments, boosting flows and challenging EMEs' ability to use capital controls to mitigate unbridled flows.     

REFORMING PENSION FUNDS IN SRI LANKA: INTERNATIONAL DIVERSIFICATION AND THE EMPLOYEES' PROVIDENT FUND

The Employees' Provident Fund (EPF) of Sri Lanka is a defined‐contribution pension fund whose pooled asset holdings consist mainly of local government bonds. Regulations prohibit international diversification, and this paper aims to quantify the extent of the potential harms, if any, caused by this constraint. To improve the robustness of the findings, we use two distinct methodologies. These include traditional mean‐variance analysis from modern portfolio theory, and Monte Carlo simulations bootstrapped from the historical data that estimate the distribution of wealth accumulated at retirement from the contributions of a hypothetical worker. Both methods produce qualitatively and quantitatively similar results: workers with risk aversion varying from aggressive to conservative will be better served by allowing international diversification. The results are particularly persuasive for the second approach. The EPF fund managers will likely behave fairly conservatively toward risk, which suggests that around half of the fund assets should be invested abroad.     

Alternate instruments to manage the capital flow conundrum: A study of selected Asian economies

Capital inflows to and outflows from emerging market economies (EME) have increased significantly since 2000. This rapid increase, accompanied by a sharp rise in volatility, has amplified the complexity of macroeconomic management in EME. While foreign capital provides additional financing for productive investment and offers avenues for risk diversification, unbridled flows exacerbate financial and macroeconomic instability. In this paper, we focus on the experience of six emerging Asian economies (EAE) in dealing with capital flows. Using quarterly data, we identify the waves of capital flows experienced by these EAE and the efficacy of the various policy measures taken. The policy choices include negotiating the trilemma (i.e. balancing the need for monetary policy autonomy, exchange rate flexibility and capital account openness), as per the demands of the macroeconomic situation. The paper also analyses the extent to which intervention in the foreign exchange market and imposition of short‐term capital flow management measures have aided countries to negotiate the trilemma. The efficacy of these responses have been varied across countries, implying that a judicious mix of these measures, along with improvement in financial and institutional development, is required to effectively counter the vagaries of capital flows.     

Wealth,Natural Capital,and Sustainable Development: Contrasting Examples from Botswana and Namibia

Theoretical work has demonstrated that sustainable development requires non-declining per capita wealth, where wealth is defined to include produced, natural, human and social capital. Several studies have attempted to measure total national wealth or changes in wealth, but have been seriously hampered by a lack of data, especially for natural and human capital. To address this problem, the UN and other international statistical agencies developed a standardized framework for environmental accounts, the System of integrated Environmental and Economic Accounts (SEEA). Using the newly available asset accounts for natural capital, national wealth accounts are constructed and used to assess the contrasting development paths of Botswana and Namibia. Botswana, with an explicit policy of reinvestment of resource rents, has roughly tripled per capita wealth and national income over the past two decades. Namibia, with no explicit policy to use natural capita to build wealth, has seen per capita wealth and income decline.     

Distribution of wealth and incomplete markets: Theory and empirical evidence

This paper analyses the equilibrium distribution of wealth in an economy where firms’ productivities are subject to idiosyncratic shocks, returns on factors are determined in competitive markets, households have linear consumption functions and government imposes taxes on capital and labour incomes and equally redistributes the collected resources to households. The equilibrium distribution of wealth is explicitly calculated and its shape crucially depends on market incompleteness. With incomplete markets it follows a Paretian law in the top tail and the Pareto exponent depends on the saving rate, on the net return on capital, on the growth rate of population, and on portfolio diversification. The characteristics of the labour market crucially affects the bottom tail, but not the upper tail of the distribution of wealth in the case of completely decentralized labour market. The analysis also suggests a positive relationship between growth and wealth inequality. The theoretical predictions find a corroboration in the empirical evidence of United States in the period 1989-2004.     

Credit market imperfection,lack of entrepreneurship and capital outflow from a developing economy

This paper explores the impact of credit market imperfection on lack of demand for capital, trade, and capital flows in an economy with wealth heterogeneity. In particular, we look at the implications of wealth heterogeneity. We show that the low return of capital and lower output of credit-intensive output in autarky may reflect lack of entrepreneurship and demand for credit due to wealth heterogeneity and eventually may lead to capital outflow from a capital-scarce country. This is a different way of echoing the sentiment of the well–known Lucas paradox, which suggests that capital might flow from the poor to the rich countries. We also show the possibility of trade and capital flow being complements and not substitutes, as is usual in standard trade models driven by factor abundance.     

Regional integration and innovation offshoring with occupational choice and endogenous growth

We study the effects of regional integration on patterns of production and offshoring in a two-region model of occupational choice and endogenous growth. The distribution of asset wealth and allocation of heterogenous workers into innovation and production determines relative market size. When trade costs and knowledge dispersion are high (low), the asset wealthy (poor) region has a larger market and greater shares of innovation and manufacturing. For low to intermediate levels of trade costs, innovation and manufacturing offshoring flows toward the larger region, but when trade costs and knowledge dispersion are high, offshoring flows from the larger asset wealthy region to the smaller asset poor region. Economic growth is unaffected by the shifts in innovation and production that coincide with changes in relative market size.     

The instantaneous capital market line

Summary. We show that if the intercept and slope of the instantaneous capital market line are deterministic, then investors will not hold any hedge portfolios in the sense of Merton [9, 11]. They will choose portfolios that plot on the capital market line, and they will slide up and down the capital market line over time as their wealth and risk tolerance change. This result allows us to aggregate over investors and derive a single factor CAPM where the first and second moments of security returns may change stochastically over time and markets are potentially incomplete.Received: 21 June 2004, Revised: 10 December 2004, JEL Classification Numbers: G11, G12.An earlier version of this paper was presented at the Econometric Society Meeting in Pasadena (1997) under the title “Portfolio selection and asset pricing with dynamically incomplete markets and time-varying first and second moments”.