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A Portfolio Theory of International Capital Flows

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  • Michael B. Devereux
  • Makoto Saito

Abstract

This paper constructs a model in which the currency composition of national portfolios is an essential element in facilitating capital ‡ows between countries. In a two country environment, each country chooses optimal nominal bond portfolios in face of real and nominal risk.Current account deficits are financed by increases in domestic currency debt, but balanced by increases in foreign currency credit. This is combined with an evolution of risk-premiums such that the rate of return on the debtor country’s gross liabilities is lower than the return on its gross assets. This ensures stability of the world wealth distribution.

Suggested Citation

  • Michael B. Devereux & Makoto Saito, 2006. "A Portfolio Theory of International Capital Flows," The Institute for International Integration Studies Discussion Paper Series iiisdp124, IIIS.
    • Handle: RePEc:iis:dispap:iiisdp124
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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