Portfolio and welfare consequences of debt market dominance |
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| Institution: | 1. École Polytechnique Fédérale de Lausanne, Switzerland;2. International Monetary Fund, 700 19th Street, N.W., Washington, D.C. 20431, United States;1. DIW Berlin and Humboldt University, Mohrenstrasse 58, 10117 Berlin, Germany;2. Centre for Economic Policy Research (CEPR), 77 Bastwick Street, EC1V 3PZ London, UK;3. Department of Finance, BI Norwegian Business School, Nydalsveien 37, 0484 Oslo, Norway;4. Finance Faculty, Cass Business School, City University London, 106 Bunhill Row, London EC1Y 8TZ, UK;5. Bank of Italy, Via Nazionale 91, 00184 Rome, Italy;1. London Business School, Regent?s Park, London NW1 4SA, United Kingdom;2. Department of Economics, University of Leicester, Leicester LE1 7RH, United Kingdom;1. International School of Economics and Management, Capital University of Economics and Business, Beijing, China;2. University of California, Department of Economics, Santa Barbara, CA 93106, United States;1. Money Market, Swiss National Bank, Boersenstrasse 15, 8022 Zurich, Switzerland;2. Financial Stability – Oversight, Swiss National Bank, Bundesplatz 1, 3003 Bern, Switzerland |
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| Abstract: | The ability to issue debt that pays in units of the domestic good leads a country to accumulate a large and negative net foreign asset position while maintaining a positive position in equity. This debt market advantage also helps to explain the weak relationship between the real exchange rate and relative consumption. Our stylized model matches the key facts about the U.S. international portfolio, the U.S. real exchange rate, and explains nearly 50% of the observed variation in the valuation effects. We find that taxing bond market transactions increases the volatility of the exchange rate, capital flows and allocations. In contrast, taxing equity positions stabilizes the exchange rate and capital flows while having little impact on the allocation. Lastly, the paper describes a global solution method for portfolio problems under incomplete markets. |
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| Keywords: | International portfolio choice Global imbalances Incomplete markets Bond market |
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