IMF Working Papers

Why are Countries’ Asset Portfolios Exposed to Nominal Exchange Rates?

By Jonathan J. Adams, Philip Barrett

December 22, 2017

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Jonathan J. Adams, and Philip Barrett. Why are Countries’ Asset Portfolios Exposed to Nominal Exchange Rates?, (USA: International Monetary Fund, 2017) accessed September 19, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

Most countries hold large gross asset positions, lending in domestic currency and borrowing in foreign. Thus, their balance sheets are exposed to nominal exchange rates. We argue that when asset markets are incomplete, nominal exchange rate exposure allows countries to partially insure against shocks that move real exchange rates. We demonstrate that asset market incompleteness can simultaneously generate realistic gross asset positions and resolve the Backus-Smith puzzle: that relative consumptions and real exchange rates correlate negatively. We also show that local perturbation methods that use stabilizing endogenous discount factors are inaccurate when average and steady state interest rates differ. To address this, we develop a novel global solution method to accurately solve the model.

Subject: Bonds, Consumption, Exchange rates, Financial institutions, Financial markets, Foreign exchange, National accounts, Real exchange rates, Securities markets

Keywords: Asset dynamics, Asset market incompleteness, Backus-Smith correlation, Backus-Smith puzzle, Bonds, Consumption, Consumption puzzle, Country portfolios, Exchange rate, Exchange rates, Global, Goods firm, Gross asset positions, Home bias, Interest rate parity, International business cycles, Price level, Real exchange rates, Securities markets, WP

Publication Details

  • Pages:

    48

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2017/291

  • Stock No:

    WPIEA2017291

  • ISBN:

    9781484335468

  • ISSN:

    1018-5941