International Currency Portfolios

March 1, 2009

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Format: Chicago

Michael Kumhof. International Currency Portfolios, (USA: International Monetary Fund, 2009) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper develops a theory of international currency portfolios that holds in general equilibrium, and that is therefore not subject to the criticisms directed at the portfolio balance literature of the 1980s. It shows that, under plausible assumptions about fiscal policy, the relationship between the rates of return of different currency bonds is not correctly described by an arbitrage relationship but instead also depends on outstanding bond stocks. Other findings are: (1) There is a monotonically increasing relationship between domestic interest rates and the portfolio share of domestic currency denominated assets. This relationship is steep at low levels of government debt, and almost flat at high levels of government debt. (2) Optimal private sector foreign currency positions are negative, and their size is decreasing in exchange rate volatility. Under volatile exchange rates large negative aggregate net foreign asset positions can only be rationalized by assuming large public sector borrowing from foreign governments. (3) For a baseline economy with zero net foreign assets, open market sales of domestic government debt lead to valuation gains (losses) when the country as a whole has a short (long) position in foreign currency. (4) A fiscal theory of exchange rate determination is compatible with general equilibrium in a two-country world. (5) Equilibria are determinate when both fiscal and monetary policy are passive.

Subject: Central banks, Currencies, Exchange rates, Financial institutions, Foreign exchange, Monetary base, Money, Open market operations, Stocks

Keywords: Asset market intervention, Currencies, Currency asset, Currency assets, Currency lending, Currency risk, Exchange rate volatility, Exchange rates, Financial asset, Fiscal policy, Foreign currency, Foreign currency bond, Global, Imperfect asset substitutability, Interest parity, Monetary base, Money stock, Open market operations, Portfolio balance theory, Portfolio share, Price level, Real value, Stocks, WP

Publication Details

Pages:

35
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2009/048
Stock No:

WPIEA2009048
ISBN:

9781451871968
ISSN:

1018-5941

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