International Portfolios, Current Account Dynamics and Capital Accumulation

Despite the liberalization of capital ‡ows among OECD countries, equity home bias remains sizable, but is now less severe than in earlier decades; as a result, ‡uctuations in returns on foreign assets have a substantial e¤ect on countries’wealth. As documented in this paper, changes in net foreign asset positions (NFA) are highly volatile, serially uncorrelated and countercyclical. We show that a two-country RBC model with productive investment and unrestricted international trade in stocks and bonds can explain these facts. Capital accumulation and shocks to the e¢ ciency of investment are key ingredients for the success of the model. In contrast to related models that abstract from capital, equity home bias is not sensitive to preference parameters. In the model, NFA changes are largely driven by capital gains/losses due to movements in equity prices. The model thus matches the high volatility and low serial correlation of NFA changes. We compare settings with complete and incomplete …nancial markets. Imperfect hedging is required to generate a realistic conventional current account measure that solely re‡ects aggregate net ‡ows of assets between countries. JEL classi…cation: F2, F3, G1. Keywords: international equity and bond portfolios; capital ‡ows; current account; capital accumulation; news shocks; valuation e¤ects. — — — — — — — — — — — — — — — — — — — — — – We thank Pierre-Olivier Gourinchas and Jonathan Heathcote for useful discussions. Robert Kollmann thanks ECARES, FNRS and the National Bank of Belgium for …nancial support. Nicolas Coeurdacier; Department of Economics; London Business School; Regent’s Park; London NW1 4SA; United Kingdom; [email protected]. Robert Kollmann; ECARES; Université Libre de Bruxelles; 50 Av. Franklin Roosevelt; CP 114; B-1050 Brussels; Belgium; [email protected]