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Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds

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Abstract
Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterized by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the conse- quences of an increase in the importance of Sovereign Wealth Funds (SWFs). Specifically, we ask what would happen if 'excess' reserves held by Emerging Markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the 'exorbitant privilege', i.e., the excess return the US receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.

Suggested Citation

  • Sá, F. & Viani, F., 2010. "Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds," Cambridge Working Papers in Economics 1029, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:1029
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    10. Olivier Blanchard & Francesco Giavazzi & Filipa Sa, 2005. "International Investors, the U.S. Current Account, and the Dollar," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 1-66.
    11. Pierre-Olivier Gourinchas & Hélène Rey, 2007. "From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 11-66, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Hristov, Nikolay & Hülsewig, Oliver & Wollmershäuser, Timo, 2020. "Capital flows in the euro area and TARGET2 balances," Journal of Banking & Finance, Elsevier, vol. 113(C).
    2. Chahir Zaki & Raimundo Soto & Ibrahim El Badawi, 2018. "Sovereign Wealth Funds, Cross-Border Investment Bias and Institutions: The Case of Arab Countries2," Working Papers 1173, Economic Research Forum, revised 25 Mar 2008.
    3. Timmer , Yannick, 2015. "TARGET2 balances and the adjustment of capital flows in the Euro area," European Economic Letters, European Economics Letters Group, vol. 4(1), pages 15-19.
    4. Filipa Sa & Pascal Towbin & Tomasz Wieladek, 2011. "Low interest rates and housing booms: the role of capital inflows, monetary policy and financial innovation," Globalization Institute Working Papers 79, Federal Reserve Bank of Dallas.
    5. Steiner, Andreas, 2014. "Current account balance and dollar standard: Exploring the linkages," Journal of International Money and Finance, Elsevier, vol. 41(C), pages 65-94.
    6. Sa, Filipa & Wieladek, Tomasz, 2010. "Monetary policy, capital inflows and the housing boom," Bank of England working papers 405, Bank of England.
    7. Snorre Lindset & Knut Anton Mork, 2019. "Risk Taking and Fiscal Smoothing with Sovereign Wealth Funds in Advanced Economies," IJFS, MDPI, vol. 7(1), pages 1-24, January.
    8. Simon Shui-Ming Wan, 2017. "Credit policy, real exchange rate volatility and moral hazard," International Economics and Economic Policy, Springer, vol. 14(4), pages 553-578, October.
    9. Filipa Sá & Tomasz Wieladek, 2015. "Capital Inflows and the U.S. Housing Boom," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(S1), pages 221-256, March.

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    More about this item

    Keywords

    portfolio preferences; sudden stops; imperfect substitutability; global imbalances; sovereign wealth funds;
    All these keywords.

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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