NBER Publications by Anna Pavlova

Recent evidence on the importance of cross-border equity flows calls for a rethinking of the standard theory of external adjustment. We introduce equity holdings and portfolio choice into an otherwise conventional open-economy dynamic equilibrium model. Our model is simple and admits a closed-form solution regardless of whether financial markets are complete or incomplete. We find that the excessive emphasis put in the literature on solving models with incomplete markets for the sole purpose of obtaining nontrivial implications for the current account is misplaced. We revisit the current debate on the relative importance of the standard vs. the capital-gains-based (or "valuation'') channels of the external adjustment and establish that in our framework they are congruent. Our model's impli...

This paper examines the co-movement among stock market prices and exchange rates within a three-country Center-Periphery dynamic equilibrium model in which agents in the Center country face portfolio constraints. In our model, international transmission occurs through the terms of trade, through the common discount factor for cash flows, and, finally, through an additional channel reflecting the tightness of the portfolio constraints. Portfolio constraints are shown to generate endogenous wealth transfers to or from the Periphery countries. These implicit transfers are responsible for creating contagion among the terms of trade of the Periphery countries, as well as their stock market prices. Under a portfolio constraint limiting investment of the Center country in the stock markets of th...

This paper develops a simple two-country, two-good model, in which the real exchange rate, stock and bond prices are jointly determined. The model predicts that stock market prices are correlated internationally even though their dividend processes are independent, providing a theoretical argument in favor of financial contagion. The foreign exchange market serves as a propagation channel from one stock market to the other. The model identifies interconnections between stock, bond and foreign exchange markets and characterizes their joint dynamics as a three-factor model. Contemporaneous responses of each market to changes in the factors are shown to have unambiguous signs. These implications enjoy strong empirical support. Estimation of various versions of the model reveals that most of t...