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A Theory of Gross and Net Capital Flows over the Global Financial Cycle

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  • J. Scott Davis
  • Eric Van Wincoop

Abstract

We develop a theory to account for changes in gross and net capital flows over the global financial cycle (GFC). The theory relies critically on portfolio heterogeneity among investors within and across countries, related to risky portfolio shares and portfolio shares allocated to foreign assets. A global drop in risky asset prices during a downturn of the GFC changes relative wealth within and across countries due to portfolio heterogeneity. This leads to changes in gross and net capital flows that are consistent with the stylized facts: all countries experience a decline in gross capital flows (retrenchment), while countries that have a net debt of safe assets experience a rise in total net outflows and net outflows of safe assets and a drop in net outflows of risky assets. The model is applied to 20 advanced countries and calibrated to micro data related to within country portfolio heterogeneity, as well as cross country heterogeneity of net foreign asset positions of safe and risky assets. The implications of the calibrated model for gross and net capital flows are quantitatively consistent with the data.

Suggested Citation

  • J. Scott Davis & Eric Van Wincoop, 2021. "A Theory of Gross and Net Capital Flows over the Global Financial Cycle," Globalization Institute Working Papers 410, Federal Reserve Bank of Dallas, revised 20 Dec 2022.
    • Handle: RePEc:fip:feddgw:93046
    DOI: 10.24149/gwp410r1
    Note: The previous version of the paper circulated with the title "A Theory of the Global Financial Cycle."
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    Cited by:

    1. Andreas M. Fischer & Dr. Pinar Yesin, 2023. "The kindness of strangers: Brexit and bilateral financial linkages," Working Papers 2023-02, Swiss National Bank.

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    More about this item

    Keywords

    Global Financial Cycle; Capital Flows; Current Account; Portfolio Heterogeneity;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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