King's College London

Research portal

Shifts in portfolio preferences of international investors: an application to sovereign wealth funds

Research output: Contribution to journalArticle

Filipa Goncalves e Sa, Francesca Viani

Original languageEnglish
Article numberN/A
Pages (from-to)868-885
Number of pages17
JournalReview of International Economics
Volume21
Issue number5
Publication statusPublished - 2013

King's Authors

Abstract

Reversals in capital infl ows 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 characterised 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 consequences 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 diversifi cation 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’, ie, the excess return the United States 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.

View graph of relations

© 2018 King's College London | Strand | London WC2R 2LS | England | United Kingdom | Tel +44 (0)20 7836 5454