The external wealth of nations mark II: Revised and extended estimates of foreign assets and liabilities, 1970-2004

We construct estimates of external assets and liabilities for 145 countries for 1970-2004. We describe our estimation methods and key features of the data at the country and global level. We focus on trends in net and gross external positions, and the composition of international portfolios. We document the increasing importance of equity financing and the improvement in the external position for emerging markets, and the differing pace of financial integration between advanced and developing economies. We also show the existence of a global discrepancy between estimated foreign assets and liabilities, and identify the asset categories accounting for this discrepancy.     

Home bias and high turnover: Dynamic portfolio choice with incomplete markets

Why do investors trade a lot in foreign assets and hold so little of them in their portfolios? This paper shows that both observations can arise naturally in the presence of nondiversifiable nontraded consumption risk when each country specializes in production, preferences exhibit consumption home bias, and asset markets are incomplete. Using a general equilibrium two-country, two-sector (tradable and nontradable) model of the world economy with production I show that low diversification occurs because variations in relative prices (i) increase the riskiness of foreign assets and (ii) facilitate risk-sharing across countries. Large and volatile capital flows are necessary to take advantage of international risk premia differentials that occur in response to productivity changes in the nontradable sector. I characterize the optimal portfolio holdings, the evolution of the investment opportunity set, the risk premium, and the dynamics of capital flows using a new methodology for solving dynamic general equilibrium models with incomplete markets and portfolio choice.     

Chinese FDI in New Zealand: What Are Chinese Investors Looking For?

In recent years, there has been unparalleled growth in outward foreign direct investment from China. Traditional Western‐dominated international business theory proposes that asset exploitation is necessary for firms undertaking foreign investment. However, more recently, studies suggest asset augmentation is more important for multinational enterprises from emerging countries. This article examines the acquisition by two Chinese firms—Agria and Haier—of two iconic New Zealand firms, each with a significant international presence—PGG Wrightson and Fisher & Paykel. The article determines that Agria and Haier invested to acquire strategic assets in order to strengthen their position in the Chinese market as well as build and sustain a global position. Strategic intent was an important factor in deciding where to invest, and strategic assets complementary to their own competitive advantages were sought by the Chinese firms. © 2016 Wiley Periodicals, Inc.     

Are asset price guarantees useful for preventing Sudden Stops?: A quantitative investigation of the globalization hazard-moral hazard tradeoff

An implication of the globalization hazard hypothesis is that ‘Sudden Stops’ caused by global financial frictions could be prevented by offering foreign investors price guarantees on emerging markets assets. These guarantees create a tradeoff, however, because they weaken globalization hazard while creating international moral hazard. We study this tradeoff using a quantitative, equilibrium asset-pricing model. Without guarantees, margin calls and trading costs cause Sudden Stops driven by a Fisherian deflation. Price guarantees prevent this deflation by propping up foreign demand for assets. The effectiveness of price guarantees, their distortions on asset markets, and their welfare implications depend critically on whether the guarantees are contingent on debt levels and on the price elasticity of foreign demand for domestic assets.     

Getting beyond carry trade: What makes a safe haven currency?

The main objective of this paper is to investigate the fundamentals of safe haven currencies, which are those currencies that provide an hedge for a reference portfolio of risky assets, conditional on shocks to global risk aversion. We analyse a large panel of 52 currencies in advanced and emerging countries over almost 25 years of data. We find that only a few factors are robustly associated to a safe haven status, most notably the net foreign asset position, an indicator of external vulnerability, and whether currencies have been a good hedge in the past. In addition, the currencies of large, less financially open economies are a good hedge against global risk aversion shocks. By contrast, the level of the interest rate spread vs. the US is significant only during the latest crisis. Finally, we find some evidence of non-linearity as the importance of the fundamentals is stronger during crisis times.     

Why do foreigners invest in the United States?

Why are foreigners willing to invest over $2 trillion per year in the United States? This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less developed financial markets. The magnitude of this effect decreases with income per capita. Countries that trade more with the United States also have greater portfolio shares in U.S. equity and bond markets. These results support recent theoretical work on the role of financial development in sustaining global imbalances and have important implications for whether the United States can continue to attract sufficient financing from abroad without major changes in asset prices and returns, especially in bond markets.     

Decomposing the Income Insurance Channel across OECD and Emerging Markets

This paper investigates the underlying forces driving income insurance channels for the Organisation for Economic Co‐operation and Development (OECD) and emerging markets. We find income insurance channels across countries to be driven by different subchannels. For the OECD, income insurance is mostly governed by payments for financial liabilities; for the emerging markets, income flows from nationals working abroad constitute the main income smoother. Despite the growth in cross‐border financial asset trading over the years, we could not find evidence of income smoothing via foreign assets receipts for the OECD. For the majority of emerging markets, neither receipts of foreign assets nor foreign liability payments are strong enough to insure income as well.     

The impact of sovereign wealth funds on global financial markets

If sovereign wealth funds act similarly to private investors and thus allocate foreign assets according to market capitalisation rather than liquidity considerations, official portfolios reduce their “bias” towards the major reserve currencies — the US dollar and the euro. As a result, more capital flows “downhill“ from rich to less wealthy economies. In this scenario, the euro area and the United States would be subject to net capital outflows while Japan and the emerging markets would attract net capital inflows. The potential implications of a rebalancing of international capital flows for stock prices, interest rates and exchange rates remain uncertain, however. The authors wish to thank Marcel Fratzscher for excellents comments. The views expressed in this paper are those of the authors and do not necessarily reflect those of the European Central Bank.     

International portfolios, capital accumulation and foreign assets dynamics

Despite the liberalization of capital flows among OECD countries, equity home bias remains sizable. We depart from the two familiar explanations of equity home bias: transaction costs that impede international diversification, and terms of trade responses to supply shocks that provide risk sharing, so that there is little incentive to hold diversified portfolios. We show that the interaction of the following ingredients generates a realistic equity home bias: capital accumulation and international trade in stocks and bonds. In our model, domestic stocks are used to hedge fluctuations in local wage income. Terms of trade risk is hedged using bonds denominated in local goods and in foreign goods. In contrast to related models, the low level of international diversification does not depend on strongly countercyclical terms of trade. The model also reproduces the cyclical dynamics of foreign asset positions and of international capital flows.     

Dollar illiquidity and central bank swap arrangements during the global financial crisis

While the global financial crisis was centered in the United States, it led to a surprising appreciation in the dollar, suggesting global dollar illiquidity. In response, the Federal Reserve partnered with other central banks to inject dollars into the international financial system. Empirical studies of the success of these efforts have yielded mixed results, in part because their timing is likely to be endogenous. In this paper, we examine the cross-sectional impact of these interventions. Theory consistent with dollar appreciation in the crisis suggests that their impact should be greater for countries that have greater exposure to the United States through trade and financial channels, less transparent holdings of dollar assets, and greater illiquidity difficulties. We examine these predictions for observed cross-sectional changes in CDS spreads, using a new proxy for innovations in perceived changes in sovereign risk based upon Google-search data. We find robust evidence that auctions of dollar assets by foreign central banks disproportionately benefited countries that were more exposed to the United States through either trade linkages or asset exposure. We obtain weaker results for differences in asset transparency or illiquidity. However, several of the important announcements concerning the international swap programs disproportionately benefited countries exhibiting greater asset opaqueness.     

Pitfalls of Downside Performance Measures with Arbitrary Targets

Downside performance measures relate above target returns with lower partial moments. They were developed to resolve restrictive assumptions of the classical Sharpe ratio. While the Sharpe ratio evaluates whether portfolios of a mutual fund and the risk‐free asset dominate passive portfolios of the benchmark and the risk‐free asset, this characteristic cannot be transferred to downside performance measures with arbitrary targets. We show that downside performance measures assign different values to passive benchmark strategies if the target differs from the risk‐free rate. This effect can lead to reverse rankings of financial assets. Therefore, downside performance measures are only applicable in asset management if the target is set equal to the risk‐free rate.     

Including emerging markets in international momentum investment strategies

Momentum return investment strategies that diversify across countries provide lower portfolio standard deviations and/or increased expected returns. These diversification benefits are larger when adding emerging markets than when adding developed markets, and they are larger than would be suggested by diversifying with long-only portfolios. Using data on almost 16,000 firms from 22 developed and 18 emerging markets over the 1990–2004 period, we confirm the profitability of momentum trading strategies in both developed and emerging markets and document the diversification benefits of including emerging markets in an international momentum portfolio investment strategy.     

Institutions,Corporate Governance and Capital Flows

Countries with weaker domestic investor protection hold less diversified international portfolios. An equilibrium business cycle model of North-South capital flow with corporate governance frictions between outside investors and corporate insiders explains this phenomenon through two channels. First, weak governance leads to concentrated ownership in the South because international diversification by insiders is penalized by lower stock market valuation. This reduces the float portfolio, or the supply of South assets. Second, weak governance tilts the demand of South outside investors towards domestic assets to hedge labor income risk. This is due to a higher share of labor in income, which increases labor income risk. In addition, the dynamics of investment under insider control leads relative dividend and labor income to be more negatively correlated in the South, making domestic assets a better hedge against local labor income risk. I find that the insider ownership and hedging channels are responsible for at least 29% and 11%, respectively, of the cross-country variation in international diversification. Thus, weak institutions lower international diversification primarily through concentrated ownership of firms, with outsider hedging also playing a quantitatively significant role.     

Local currency systemic risk

Emerging country governments increasingly issue local currency denominated bonds and foreign investors have been increasing their holdings of these assets. By issuing debt denominated in local currency, emerging country governments eliminate exchange rate risk. The growing stock of local currency government debt in the financial portfolios of foreign investors increases their diversification and exposure to fast growing economies. In this paper, we highlight some of the risks associated to this recent trend. First, we adopt the CoV aR risk-measure to estimate the vulnerability of individual countries to systemic risk in the market for local currency government debt. Second, we show that our country-level estimates of vulnerability increase with the share of local currency debt held by foreign investors. A version of the old adage “When New York sneezes, London catches a cold,” used often to describe the relationship between the stock markets in these two cities, still applies between individual emerging countries and the aggregate market for local currency government debt.     

When Do Long‐term Imbalances Lead to Current Account Reversals?

We extend the literature on sharp reductions in current account deficits by taking into account not only short‐term determinants, but also the deviation of net foreign assets from their long‐run equilibrium level. First, we analyse the long‐term relationship between net foreign assets and a set of explanatory variables and construct a measure of imbalances. Next, we model current account reversals by incorporating this new measure and compare the predictive power of this model with the baseline specification that does not account for long‐term imbalances. Our new model has a superior performance in and out‐of‐sample, especially when we control for the sign of imbalances. We also find that low net foreign assets do not necessarily lead to sharp reductions in current account deficits; it is rather the situation when they are below their equilibrium level that triggers reversals. Finally, we document that our new measure of net foreign asset imbalances is important only for developing countries, whereas standard models perform well for industrial economies.     

Using macro cross‐border trade data to better understand micro‐level country of origin effects

The article adapts an estimation methodology from the border effects literature to reveal consumer ethnocentrism versus cosmopolitanism in each country, and animosity versus nostalgia between country pairs. The measurements rely on actual macro cross‐border trade data rather than individual purchase intentions typically used in the international marketing literature. The results from early 2010s suggest that purchasing intentions against imports found in this literature do not necessarily translate into actual consumption behavior in international trade. It is quite possible that the consumers are unable to assess country of origin of production despite growing ethnocentrism, and base their actual purchases on perceived origin of product brands. Specifically, it is found that most countries are cosmopolitan rather than ethnocentric, particularly developed countries, favoring any foreign product over domestic products. Most countries also have nostalgic purchasing behavior from specific trade partners with historical linkages. Outside the specific traditional animosities between a country pair, a developed country is relatively less open to imports from another developed trade partner, while an emerging country welcomes it more especially from another emerging trade partner.     

Direction of outward FDI of EMNEs: Evidence from the Indian pharmaceutical sector

This article seeks to add to the small but growing literature of emerging‐market multinational enterprises (EMNEs). Using two linked large firm‐level databases, it seeks to explore the determinants of outward investment of Indian pharmaceutical companies, distinguishing between developed‐ versus developing‐country destinations. It specifically examines the impact of two firm‐level characteristics that embody “non‐OLI” [ownership, location, and internalization] firm‐specific capabilities of EMNEs. The finding of this study is that family firms are keen on investing in other developing countries but much less so in developed countries. However, international linkages in the form of foreign investors offset this. © 2011 Wiley Periodicals, Inc.     

Unpacking Institutional Distance: Addressing Human Capital Development and Emerging‐Market Firms’ Ownership Strategy in an Advanced Economy

As latecomers to global business competition, emerging‐market multinational companies (EMNCs) utilize cross‐border mergers and acquisitions (M&As) to quickly acquire strategic assets, resulting in an improved competitive position. Advanced markets with well‐established firms and well‐developed market‐supporting institutions become particularly important destinations for EMNCs’ foreign operations. Institutional distance, which represents conflicting legitimacy requirements between the host and home institutional environments, is expected to be negatively associated with the foreign acquirer's ownership position. The current study examines a sample of EMNCs’ cross‐border M&As in the United States between 2005 and 2011 and reveals the unique nature of EMNCs’ ownership strategies. Taking both formal and informal institutions into consideration, our findings suggest that EMNCs originating in countries with lower levels of human capital development may have more urgency in seeking ownership control in advanced markets and are less influenced by the negative association of institutional distance in their ownership strategy. © 2016 Wiley Periodicals, Inc.     

China's segmented stock market: An application of the conditional international capital asset pricing model

China's segmented stock market provides an opportunity to study conditional international asset pricing from multiple viewpoints—domestic and foreign. We use the multivariate GARCH-M framework of De Santis and Gérard [De Santis, G., and Gérard, B., 1998. How big is the premium for currency risk? Journal of Financial Economics 49, pp. 375–412.], but add conditional local specific risk and find global, local, and currency risk to be priced and time-varying in Chinese markets, suggesting mild segmentation for developing country markets. The time-varying price of currency risk indicates that the strict currency restrictions in China do not sufficiently reduce currency risk to stabilize the price of currency risk. We also find that the price of local risk in the Chinese A stock market is non-time-varying relative to the developed market, but time-varying relative to the emerging market. This finding implies that the Chinese A stock market is more comparable to a developed market than an emerging market. However, results on Chinese B shares show the opposite relationship: from a foreign investor's perspective, Chinese B shares are better categorized as being emerging than developed. This is further supported by an Engle–Granger cointegration test.     

Sterilisation and Monetary Control by the GCC Member Countries

The prevailing dollar peg of the Gulf Cooperation Council (GCC) countries and the absence of any significant current and capital account restrictions led some to believe that these countries have lost monetary independence. However, the paper presents evidence that interest rates of the GCC countries did not converge to the interest rates of the US implying that the assets of the GCC countries are not perfect substitutes to the US assets. This imperfect asset substitutability has allowed the GCC countries to manoeuvre their monetary policies and the central banks of the GCC countries have had some control over their money growth rates by sterilising the changes in international reserves. Results indicate that the monetary authorities of these countries used domestic credit policy to attain some domestic policy objective while engaging in sterilised foreign exchange intervention. This result implies that the proposed GCC central bank should be able to maintain the monetary independence as a group and can reap the benefit of monetary efficiency of the proposed Gulf Monetary Union.