Research Papers

“The Current Account as a Dynamic Portfolio Choice Problem”, joint with A. Lowenkron.
Job Market Paper [Job Market Paper]
Presented at the Setimo Encontro Brasileiro de Financas in Sao Paulo, Brazil, 2007.

Abstract: The current account problem can be understood as the outcome of investment decisions made by domestic and foreign investors. Focusing on this asset allocation aspect of the problem, we analyze the implications that time-varying portfolio shares have on the dynamics of the current account. We emphasize the importance of innovations on the investment opportunity set, captured by changes in expected asset returns, as the main mechanism behind variations in countries’ portfolios. We provide a theoretical framework and, most significantly, empirically test this mechanism on the dynamics of the current account. We evaluate the predictions of a partial-equilibrium model of the current account, with dynamic portfolio choices. Using data for the U.S. and Japan, we show that variations in investment opportunities change agents' optimal portfolios in a direction consistent with the actual bilateral current account movements. Furthermore, we provide econometric evidence of a robust positive relation between our predicted and the actual bilateral current account series. Therefore, our approach highlights changes in expected asset returns as an important mechanism to explain international capital flows.