Stationary Equilibria in International Portfolio Choice Model

Abstract

We build a two-country two-good model of international portfolio choice and current account adjustment. We calibrate the model so that it is consistent with the home equity bias and consumption-real exchange rate disconnect. Financial markets are incomplete and trade three assets: domestic and foreign stocks and an international bond. First we show that if the international bond is denominated in domestic good than domestic economy can have a negative net foreign asset position up to 22 % of GDP. This result suggests that the international role of the U.S. dollar for portfolio decisions cannot be ignored. Consistent with the data, we also find that the negative NFA position is achieved by accumulating debt. Second, we show that if the volatility in the domestic economy decreased relative to the rest of the world, as happened after 1984, then the net foreign asset (NFA) position could worsen. This provides another explanation why the U.S. NFA position has been declining. 1

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