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International Capital Flows

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  • Eric Van Wincoop
  • Cedric Tille

Abstract

The sharp increase in both gross and net capital flows over the past two decades has led to a renewed interest in their determinants. Most existing theories of international capital flows are in the context of models with only one asset, which only have implications for net capital flows, not gross flows. Moreover, there is no role for capital flows as a result of changing expected returns and risk-characteristics of assets as there is no portfolio choice. In this paper we develop a method for solving dynamic stochastic general equilibrium open-economy models with portfolio choice. We show why standard first and second-order solution methods no longer work in the presence of portfolio choice, and extend them giving special treatment to the optimality conditions for portfolio choice. We apply the solution method to a particular two-country, two-good, two-asset model and show that it leads to a much richer understanding of both gross and net capital flows. The approach highlights time-varying portfolio shares, resulting from time-varying expected returns and risk characteristics of the assets, as a potential key source of international capital flows.

Suggested Citation

  • Eric Van Wincoop & Cedric Tille, 2007. "International Capital Flows," NBER Working Papers 12856, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12856
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    More about this item

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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