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Capital Flows, Volatility, and Sovereign Debt

Paper Session

Saturday, Jan. 6, 2018 2:30 PM - 4:30 PM

Pennsylvania Convention Center, 106-B
Hosted By: Econometric Society

Gradual Portfolio Adjustment: Implications for Global Equity Portfolios and Returns

Philippe Bacchetta
University of Lausanne
Eric van Wincoop
University of Virginia


Modern open economy macro models assume the continuous adjustment of international portfolio allocation. We introduce gradual portfolio adjustment into a global equity market model. Our approach differs from related literature in two key dimensions. First, the time interval between portfolio decisions is stochastic rather than fixed, leading to a smoother response to shocks. Second, rather than only considering asset returns, we also use data on portfolio shares to confront the model to the data. Conditional on reasonable risk aversion, we find that the data is consistent with infrequent portfolio decisions, with a frequency of at most once in 15 months on average.

Commodity Prices and Sovereign Default: A New Perspective on The Harberger-Laursen-Metzler Effect

Franz Hamann
Central Bank of Republic of Colombia
Enrique G. Mendoza
University of Pennsylvania
Paulina Restrepo-Echavarria
Federal Reserve Bank of St. Louis


In this paper we document the stylized facts about the relationship between international
oil price swings, sovereign risk and macroeconomic performance of oil-exporting economies. We
show that even though being a bigger oil producer decreases sovereign risk–because it increases
a country’s ability to repay–having more oil reserves increases sovereign risk by making autarky
more attractive. We then develop a small open economy model of sovereign risk with incomplete
international financial markets, in which optimal oil extraction and sovereign default interact. We
use the model to understand the mechanisms behind the empirical facts and pay special attention
to understanding the macroeconomic effects of the terms-of-trade shocks or what is known in
the literature as the Harberger-Laursen-Metzler effect: there is a positive correlation between the
terms-of-trade shocks and the trade balance (current account) which declines as shock persistence

Learning About Debt Crises

Radek Paluszynski
University of Houston


The recent European debt crisis presents a challenge to our understanding of the relationship between government bond yields and economic fundamentals. I argue that information frictions are an important missing element, and support that theory with empirical evidence on the evolution of forecast errors during the Great Recession. I build a quantitative model of sovereign default that features rare disasters and incomplete information about the country's economic outlook. Under a calibration to Portuguese economy, bond prices exhibit variable sensitivity to income shocks over time, a result of the markets' learning process about the underlying risk of economic depression.
JEL Classifications
  • A1 - General Economics