The Valuation Channel of International Adjustment By F. Ghironi , J. Lee, and A. Rebucci

1. The Valuation Channel of International AdjustmentByF. Ghironi, J. Lee, and A. Rebucci Risk Sharing Conference, October 22-23, 2010 The views expressed are those of the discussant and not those of the IDB or its Executive Board.

2. Motivation • The relative importance, working, and risk sharing role of the “financial channel” of external adjustment (GR, 2007) are the subject of an ongoing policy and academic debate • Changes in NFA can arise from: • changes in quantities and prices of goods and services: the "trade" channel of adjustment • or changes in asset prices and returns: the "financial" channel of adjustment.

3. This paper • Focuses on the pure “capital gain and loss” component of the of the financial channel of adjustment • Consistent with statistical practices and data availability

4. It makes three points: • The predictable component of valuation effects can be modeled without resorting to higher order approximations of the portfolio decision • This component is non-negligible in NFA dynamics, although its risk sharing role is difficult to isolate • The source of the shock triggering external adjustment matters

5. Outline • Model overview • Decomposing NFA • Key result • Robustness • Other results • Conclusions

6. Model overview • Standard, symmetric, two-country, DSGEportfoliomodel with: • International trade in equity • No transaction costs (results in early analysis robust) • Production under monopolistic competition (endogenous labor) and flex prices • Productivity and government shocks (asset markets are incomplete) • No trade frictions: LOP and PPP hold and no role for RER

7. Budget constraint and NFA definition

8. Decomposing first-order changes in NFA (Solution details skipped)

9. Decomposing NFA (Cont.)

10. Valuation effects in response to productivity shocks are predictable

11. Relative importance of CA and Val

12. Intuition

13. Comparison with literature

14. Robustness • Persistent shocks (DS, 2009) • When the shocks are permanent, CA does not move: the predictable component of Val is zero and the two definitions coincide (see Nguyen, 2009 for more discussion) • In NPV terms, they are irrelevant for sustainability perspective (TvW, 2008): • True, but their time profile may matter in practice (i.e., illiquidity may lead to insolvency as in some emerging market crisis of the past)

15. Differences

16. Other results • Government shocks don’t give rise to predictable valuation effects in our simple model • Interesting to investigate relative role of different shocks under alternative model structures • Role for risk sharing: valuation effects are a channel of risk sharing in the model. • Any quantification is model-dependent • More interesting to investigate this in the data from the lenses of a particular model

17. Conclusions

18. Thank you