The Valuation Channel of External Adjustment
Ongoing international financial integration has greatly increased foreign asset holdings across countries, enhancing the scope for a "valuation channel" of external adjustment (i.e., the changes in a country's net foreign asset position due to exchange rate and asset price changes). We examine this channel of adjustment in a dynamic stochastic general equilibrium model with international equity trading in incomplete asset markets. We show that the risk-sharing properties of international equity trading are tied to the distribution of income between labor income and profits when equities are defined as claims to firm profits in a production economy. For a given level of international financial integration (measured by the size of gross foreign asset positions), the quantitative importance of the valuation channel of external adjustment depends on features of the international transmission mechanism such as the size of financial frictions, substitutability across goods, and the persistence of shocks. Finally, moving from less to more international financial integration, risk sharing through asset markets increases, and valuation changes are larger, but their relative importance in net foreign asset dynamics is smaller.
For helpful comments and discussions, we thank Gianluca Benigno, Pierpaolo Benigno, Claudia Buch, Charles Engel, Pierre-Olivier Gourinchas, Henry Kim, Jinill Kim, Nobuhiro Kiyotaki, Philip Lane, Akito Matsumoto, Gian Maria Milesi-Ferretti, Maurice Obstfeld, Fabrizio Perri, Christoph Thoenissen, Eric van Wincoop, and participants in the 6th CEPR Conference of the Analysis of International Capital Markets Research Training Network, the Sveriges Riksbank conference on Structural Analysis of Business Cycles in the Open Economy, the conference on Current Account Sustainability in Major Advanced Economies at the University of Wisconsin, Madison, the 2006 CEPR ESSIM, the 2006 SED Meeting, the 2005 Winter Meeting and 2006 European Meeting of the Econometric Society, and seminars at Berkeley, Central Bank of Brazil, Federal Reserve Board, IMF, Ohio State, San Francisco Fed, U.C. Irvine, U.C. San Diego, U.C. Santa Cruz, and U.N.C. Chapel Hill. Xianzheng Kong, Emmanuel Lartey, Susanna Mursula, Margarita Rubio, Sergio Santoro, and Viktors Stebunovs provided excellent research assistance. Remaining errors are our responsibility. This project started while Fabio Ghironi was visiting the IMF Research Department. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF, IMF policy, or the views of the National Bureau of Economic Research.
Ghironi, Fabio & Lee, Jaewoo & Rebucci, Alessandro, 2015. "The valuation channel of external adjustment," Journal of International Money and Finance, Elsevier, vol. 57(C), pages 86-114. citation courtesy of