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Consumption Preferences, Asset Demands, and Distribution Effects in International Financial Markets

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  • Paul R. Krugman

Abstract

This paper is an attempt to examine some of the microeconomic foundations of this last view of the link between current accounts and exchange rata. Several authors, especially Kouri and de Macedo (1978), but also more recently Dornbusch (1980), have sought to justify the portfolio approach in terms of finance theory, deriving asset demands from a mean-variance framework and arguing that differences in the portfolios of different countries explain why changes in the world distribution of wealth affect exchange rates. What I will do in this paper is to argue that, even under seemingly favorable assumptions, these distribution effects nay run the wrong way; that if they run the right way, they will be very weak; and that the incentives for inter-national, portfolio diversification are in any case small, and can be swamped by quite modest transaction costs or other costs to diversification.

Suggested Citation

  • Paul R. Krugman, 1981. "Consumption Preferences, Asset Demands, and Distribution Effects in International Financial Markets," NBER Working Papers 0651, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:0651
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    References listed on IDEAS

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    1. Pentti J.K. Kouri & Jorge B. de Macedo, 1978. "Exchange Rates and the International Adjustment Process," Cowles Foundation Discussion Papers 488, Cowles Foundation for Research in Economics, Yale University.
    2. J. Huston McCulloch, 1975. "Operational Aspects of the Siegel Paradox," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 89(1), pages 170-172.
    3. Don E. Roper, 1975. "The Role of Expected Value Analysis for Speculative Decisions in the Forward Currency Market," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 89(1), pages 157-169.
    4. Pentti J. K. Kouri & Jorge Braga De Macedo, 1978. "Exchange Rates and the International Adjustments Process," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 9(1), pages 111-158.
    5. Dornbusch, Rudiger & Fischer, Stanley, 1980. "Exchange Rates and the Current Account," American Economic Review, American Economic Association, vol. 70(5), pages 960-971, December.
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