Final Report Summary - IFA DYNAMICS (Countries’ external balance sheets, dynamics of international adjustment and capital flows)
We construct a detailed dataset of the US external balance sheet at market value from 1952 till 2012, basing our initial estimates on war time surveys. We find strong evidence of a sizeable excess return of gross assets over gross liabilities. The centre country of the International Monetary System enjoys an “exorbitant privilege” that significantly weakens its external constraint. In exchange for this “exorbitant privilege” we document that the US provides insurance to the rest of the world in times of global stress (“exorbitant duty”). During the 2007-09 global financial crisis, wealth transfers from the US to other countries amounted to 19 % of US GDP. The centre country of the Monetary System acts as a global insurer. We build a new database to show that countries benefitted differentially from these transfers, depending on their external balance sheets. Some countries actually made losses on their debt portfolios depending on their exposures to toxic assets (ABCP conduits) and the extent of dollar shortage. The global insurance mechanism described above works provided the fiscal capacity of the centre country is large enough. As relative economic sizes are shifting , a more multipolar currency system is emerging. In such a world, emergency liquidity provision facilities have to be strengthened, for example via the IMF, to manage potentially unstable international portfolio shifts.
We assess the growth and risk sharing benefits of financial integration. From a methodological point of view, we develop the concept of risky steady state. We also develop global solution techniques to solve two-country dynamic stochastic general equilibrium models with capital accumulation. We estimate the welfare gains of financial integration for emerging and advanced economies, allowing for asymmetries in volatility, capital scarcity and size. Financial integration has an effect on the risky steady-state itself and has heterogeneous effects on growth, capital flows and consumption over time and across areas. Waves of integration by emerging markets have effects on the world real interest rate. The model can generate patterns of capital flows resembling global imbalances. Interestingly, almost in all cases, welfare gains of financial integration are found to be small, even for volatile emerging market economies.
We construct a large database of international investments of equity funds at the stock level to study dynamic investment strategies. We find that managers rebalance their positions following valuation gains and losses on parts of their portfolios, due to exchange rate risk or equity risk. This rebalancing behaviour is important to assess the contribution of mutual funds to the aggregate stability of international financial markets. We also quantify the heterogeneity in stock picking ability of funds. We have a multi-million observations dataset with large geographical coverage of funds and use quantile regressions techniques. We investigate whether we can ascribe better stock picking ability to information asymmetries.
We show that a common world factor prices a very wide cross section of risky assets (equities, corporate bonds, commodities). We decompose this factor in a volatility component and the effective risk aversion of a global investor. We also find evidence of a global financial cycle in capital flows, asset prices and in credit growth. The cycle is present on all continents, regardless of the exchange rate regime adopted by countries. This cycle co‐moves with the VIX, a measure of uncertainty and risk aversion in international markets. A VAR analysis suggests that one of the determinants of the global financial cycle is monetary policy in the centre country (the US), which affects leverage of global banks, capital flows and credit growth in the international financial system. Controlling monetary conditions on a national basis may therefore require macroprudential polices and/or capital controls.
We assess the growth and risk sharing benefits of financial integration. From a methodological point of view, we develop the concept of risky steady state. We also develop global solution techniques to solve two-country dynamic stochastic general equilibrium models with capital accumulation. We estimate the welfare gains of financial integration for emerging and advanced economies, allowing for asymmetries in volatility, capital scarcity and size. Financial integration has an effect on the risky steady-state itself and has heterogeneous effects on growth, capital flows and consumption over time and across areas. Waves of integration by emerging markets have effects on the world real interest rate. The model can generate patterns of capital flows resembling global imbalances. Interestingly, almost in all cases, welfare gains of financial integration are found to be small, even for volatile emerging market economies.
We construct a large database of international investments of equity funds at the stock level to study dynamic investment strategies. We find that managers rebalance their positions following valuation gains and losses on parts of their portfolios, due to exchange rate risk or equity risk. This rebalancing behaviour is important to assess the contribution of mutual funds to the aggregate stability of international financial markets. We also quantify the heterogeneity in stock picking ability of funds. We have a multi-million observations dataset with large geographical coverage of funds and use quantile regressions techniques. We investigate whether we can ascribe better stock picking ability to information asymmetries.
We show that a common world factor prices a very wide cross section of risky assets (equities, corporate bonds, commodities). We decompose this factor in a volatility component and the effective risk aversion of a global investor. We also find evidence of a global financial cycle in capital flows, asset prices and in credit growth. The cycle is present on all continents, regardless of the exchange rate regime adopted by countries. This cycle co‐moves with the VIX, a measure of uncertainty and risk aversion in international markets. A VAR analysis suggests that one of the determinants of the global financial cycle is monetary policy in the centre country (the US), which affects leverage of global banks, capital flows and credit growth in the international financial system. Controlling monetary conditions on a national basis may therefore require macroprudential polices and/or capital controls.