Essays on International Portfolio Allocation and Risk Sharing

186 Pages·2011·2.24 MB·English

by  Hande Küçük Tu§er

Essays on
International Portfolio Allocation
and Risk Sharing
Hande Ku¨¸cu¨k Tug˘er
A Thesis Submitted for the degree of Doctor of Philosophy
Ph.D., Economics
Department of Economics
London School of Economics and Political Science
Under the supervision of Dr. Gianluca Benigno
July 2011
Declaration
I certify that the thesis I have presented for examination for the PhD degree of the
London School of Economics and Political Science is solely my own work other than
where I have clearly indicated that it is the work of others (in which case the extent
of any work carried out jointly by me and any other person is clearly identified in it).
The copyright of this thesis rests with the author. Quotation from it is permitted,
provided that full acknowledgement is made. This thesis may not be reproduced
without the prior written consent of the author.
I warrant that this authorization does not, to the best of my belief, infringe the rights
of any third party.
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Abstract
This thesis contributes to the theoretical literature that analyses the link between
international asset trade and international risk sharing. Despite the massive increase
in cross-border asset trade since the 1990’s, consumption risk sharing across countries
remainslimited. Instandardinternationalbusinesscyclemodels, efficientrisksharing
requires that consumption should be higher in the country where it is cheaper to
consume, implying a high positive correlation between relative consumption and real
exchange rate, which is strongly rejected in the data. Recent contributions show that
it is possible to account for this so-called ‘consumption-real exchange rate anomaly’
in models with goods and financial market frictions where international asset trade
is restricted to a single non-contingent bond.
Chapter 1 analyses whether this class of models can account for the anomaly
under a richer asset market structure where agents can trade in domestic and foreign
currency bonds. Even such a small departure from the single bond economy implies
toomuchrisksharingcomparedtothedataalthoughthenumberofassetsthatcanbe
traded is less than the number of shocks affecting each economy. Introducing demand
shocks alongside sector-specific productivity shocks can improve the performance of
the model only under specific parameter and monetary policy settings. Chapter
2 extends this analysis to study the implications of international trade in equities,
portfolio transaction costs and recursive utility.
Chapter 3 studies the interaction between monetary policy and foreign currency
positions in more detail. Different monetary policy regimes can lead to different
foreign currency positions by changing the cyclical properties of the nominal ex-
change rate. These external positions, in turn, affect the cross-border transmission
of monetary policy shocks via a valuation channel. The way export prices are set
has important implications for optimal foreign currency positions and the valuation
channel when prices are sticky and financial markets are incomplete.
Chapter 4 compares the international transmission of uncertainty shocks under
alternative asset markets with an emphasis on the behaviour of net foreign assets,
exchangerateandcurrencyriskpremiumandshowsthatamodelwithrestrictedasset
trade performs better than a model with complete financial integration in matching
certain aspects of the data regarding the dynamics of these variables in response to
increased macroeconomic uncertainty.
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Acknowledgements
I owe a large debt of gratitude to my supervisor Gianluca Benigno for his constant
supportandencouragementthroughoutmystudiesattheLSE.Ihavebeenverylucky
to have the opportunity to work closely with him both as a research assistant and as a
co-author, whichprovedtobe aninvaluable learningexperience. Heintroducedmeto
many interesting topics in international macro-finance and provided many comments
and suggestions on all chapters of this thesis.
I am also indebted to Bianca De Paoli and Jens Søndergaard, with whom I worked
on the third chapter of this thesis. I benefited a lot from our discussions which
providedmewithvaluableinsightandintuition. Iamalsothankfulfortheirfriendship
and support.
The first two chapters of this thesis benefited from helpful comments by Paul
Beaudry, Nicolas Coeurdacier, Pietro Cova, Bianca De Paoli, Michael Devereux,
Charles Engel, Marcelo Ferman, Nathan Foley-Fisher, Viktoria Hnatkovska, Keyu
Jin,RobertKollmann,GiovanniLombardo,AkitoMatsumoto,In´esMorenodeBarreda,
Paolo Pesenti, Alan Sutherland and Burc Tug˘er as well as the participants at the IMF
Macro-Finance Conference, Washington 24-25 April 2008; the 13th LACEA Annual
Meeting Rio de Janeiro 2008; CEPR Conference on International Macroeconomics
and Finance, Brussels 13-14 February 2009; CEPR Conference on International Risk
Sharing, Brussels 22-23 October 2010 and the LSE money-macro work in progress
seminars.
The third chapter of this thesis benefited from helpful comments by Gu¨nter Beck,
Andy Blake, Giovanni Lombardo, Anna Lipinska and an anonymous referee for the
BankofEnglandworkingpaperseriesaswellastheparticipantsattheCEPRAnnual
Workshop on Global Interdependence and the seminars at the LSE and the Bank
of England. For the fourth chapter, I am grateful for helpful comments by Dario
Caldara, Bianca De Paoli, Keyu Jin and Anna Lipinska.
I also want to thank my colleagues at the PhD programme, with whom we shared
the ups and downs of PhD life since day one, and exchanged many ideas related to
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both course-work and research, especially Gu¨ne¸s A¸sık-Altınta¸s, Zs´ofi B´ar´any, Tim-
oth´ee Carayol, Mariano Cena, Tom Cunningham, Ziad Daoud, Marcelo Ferman,
Nathan Foley-Fisher, In´es Moreno de Barreda, Beyza Polat, Ebrahim Rahbari, San-
chari Roy, Burc Tug˘er and Jin Wang. I would like to give special thanks to Beyza,
In´es, Nathan and Ziad for their invaluable friendship and support at a time when it
was most needed. I am indebted to In´es, Nathan and Zso´fi for their help in putting
my chapters in a thesis format.
I am grateful to my undergraduate and masters professors at the Middle East
Technical University, Halis Akder, Haluk Erlat, Erdal O¨zmen and O¨zge S¸enay for
steering me towards doing a PhD in economics. I am also indebted to Hakan Kara,
my boss at the Central Bank of Turkey, for inspiring me to do a PhD and also for
making it possible.
I gratefully acknowledge financial support from the Central Bank of Turkey. I
thank the Centre for Economic Performance for granting me a desk and offering a
great research environment.
I am indebted to the members of my extended family, my grandparents Su¨reyya
and Babu¨r U¨nsal; my aunts and uncles, Nu¨ket and Emrullah Gu¨rbag˘; Deniz and
Baykan Eser; as well as my cousins, Can, Cem and Bora, for their love, support and
belief in me. I also want to thank my very good friend Bilge Baytekin for finding
ever more creative ways of motivating me and for being there for me despite being in
a different continent and a different time zone.
Lastly, I dedicate this work to my parents, Betu¨l and Vehbi Ku¨¸cu¨k, and my sister,
Gamze, in thanks for their love, support and patience through all these years we
spent apart.
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To my parents and my sister
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Contents
Acknowledgements 4
List of Tables 9
List of Figures 10
Introduction 12
1 Portfolio Allocation and International Risk Sharing 17
1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
1.2 A two-country two-sector endowment economy . . . . . . . . . . . . . 22
1.3 Relative consumption and real exchange rate under alternative asset
markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
1.4 Numerical analysis in a calibrated two-country, two-sector RBC model 47
1.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
2 Portfolio Allocation and International Risk Sharing with Trade in
Equities, Transaction Costs and Recursive Preferences 79
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
2.2 International trade in equities and bonds . . . . . . . . . . . . . . . . 81
2.3 Portfolio transaction costs . . . . . . . . . . . . . . . . . . . . . . . . 93
2.4 Recursive utility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
2.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
3 Monetary Policy Rules and Foreign Currency Positions 107
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
3.2 The model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
3.3 Optimal foreign currency position and valuation effects . . . . . . . . 116
3.4 Numerical results and robustness checks . . . . . . . . . . . . . . . . 124
3.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
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4 International Transmission of Uncertainty Shocks: The Role of Fi-
nancial Market Integration 148
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148
4.2 A two-country two-sector endowment model . . . . . . . . . . . . . . 151
4.3 International transmission of volatility shocks . . . . . . . . . . . . . 159
4.4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173
Bibliography 180
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List of Tables
1.1 International portfolios and relative consumption-real exchange rate
correlations for selected industrial countries . . . . . . . . . . . . . . 18
1.2 Some parameter definitions. . . . . . . . . . . . . . . . . . . . . . . . 30
1.3 Impact responses of relative consumption and real exchange rate to
relative supply and demand (news) shocks with trade in two bonds . 46
1.4 Baseline calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
1.5 Business cycle statistics with unanticipated shocks to sectoral TFP for
different values of trade elasticity. . . . . . . . . . . . . . . . . . . . . 55
1.6 Business cycle statistics with anticipated and unanticipated shocks to
sectoral TFP for different values of trade elasticity. . . . . . . . . . . 69
2.1 Optimal portfolios and international risk sharing with shocks to the
endowment of tradables and non-tradables . . . . . . . . . . . . . . . 90
2.2 Optimal portfolios and international risk sharing with endowment and
redistributive shocks . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
3.1 Baseline calibration and steady-state foreign bond position . . . . . . 125
3.2 Steady-state foreign bond position and domestic equity shares when
there is trade in bonds and equities . . . . . . . . . . . . . . . . . . . 132
3.3 Steady-state foreign bond position and implied valuation effects under
the baseline calibration . . . . . . . . . . . . . . . . . . . . . . . . . . 136
3.4 Conditional covariance of real exchange rate adjusted relative con-
sumption and excess returns under zero-portfolio solution . . . . . . . 137
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List of Figures
1.1 Impact responses to a positive tradable endowment shock with respect
to trade elasticity, θ, for ν > 1. . . . . . . . . . . . . . . . . . . . . . 32
2
1.2 Impact responses of relative consumption and relative prices to a 1%
increase in tradable sector productivity for different values of trade
elasticity, θ. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
1.3 Impulse responses to sector-specific productivity shocks with θ = 2.5. 59
1.4 Impulse responses to sector-specific productivity shocks with θ = 0.25. 62
1.5 Sensitivity with respect to the elasticity of substitution between trad-
ables and non-tradables, κ, in the baseline model with unanticipated
productivity shocks in each sector. . . . . . . . . . . . . . . . . . . . 65
1.6 Sensitivity with respect to the the share of non-tradables in final con-
sumption, γ, in the baseline model with unanticipated productivity
shocks in each sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
1.7 Sensitivity with respect to the degree of home bias in consumption, ν,
in the baseline model with unanticipated productivity shocks in each
sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
1.8 Sensitivity with respect to the relative variance of non-tradable shocks,
σ2 /σ2, in the baseline model with unanticipated productivity shocks
NT T
in each sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
2.1 Risksharingpropertiesofbondsversusequitiesconditionalontradable
and non-tradable endowment shocks . . . . . . . . . . . . . . . . . . 91
2.2 Optimal portfolios and relative consumption-real exchange rate corre-
lations for different values of portfolio transaction costs in the model
with endowment shocks and trade in bonds or equities. . . . . . . . . 95
2.3 Optimal portfolios and relative consumption-real exchange rate corre-
lations for different values of portfolio transaction costs in the model
with endowment and redistributive shocks and trade in two bonds and
two equities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
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