International macroeconomic implications of gradual portfolio adjustment

International macroeconomic implications of gradual portfolio adjustment

This presentation will combine insights from three recent papers:

Puzzling Exchange Rate Dynamics and Delayed Portfolio Adjustment (joint with Eric van Wincoop)

Abstract

The objective of this paper is to show that the proposal by Froot and Thaler (1990) of delayed portfolio adjustment can account for a broad set of puzzles about the relationship between interest rates and exchange rates. The puzzles include: i) the delayed overshooting puzzle; ii) the forward discount puzzle (or Fama puzzle); iii) the predictability reversal puzzle; iv) the Engel puzzle (high interest rate currencies are stronger than implied by UIP); v) the forward guidance exchange rate puzzle; vi) the absence of a forward discount puzzle with long-term bonds. These results are derived analytically in a simple two-country model with portfolio adjustment costs. Quantitatively, this approach can match all targeted moments related to these puzzles.

Infrequent Random Portfolio Decisions in an Open Economy Model (joint with Eric R. Young and Eric van Wincoop)

Abstract

Motivated by evidence of portfolio frictions at the level of both households and global mutual funds, we analyze a two-country DSGE model of the global equity market where investors have a constant probability of making a new portfolio decision. There are both dividend and financial shocks, which lead to exogenous portfolio shifts. The model is solved with a global solution method that combines a Taylor projection method with the modified Shepard’s inverse-weighting interpolation. Intuition is developed by deriving an approximated portfolio expression. A numerical illustration shows that the portfolio friction significantly affects the behavior of asset prices, expected excess returns and portfolios in response to financial shocks. For the same size financial shock, the impact is much larger with the friction. The model with the friction can account better for the observed excess return predictability and other moments involving excess returns and portfolio shares.

International Portfolio Choice with Frictions: Evidence from Mutual Funds (joint with Simon Tièche and Eric van Wincoop)

Abstract

Using data on international equity portfolio allocations of US mutual funds, we estimate a simple portfolio expression derived from a standard Markowitz mean variance portfolio model extended with portfolio frictions. The optimal portfolio depends on two benchmark portfolios, the previous month and the buy-and-hold portfolio shares, and a present discounted value of expected future excess returns. We show that equity return differentials are predictable and use the expected return differentials in the mutual fund portfolio regressions. The estimated reduced form parameters are related to the structural model parameters. The estimates imply significant portfolio frictions and a modest rate of risk-aversion. While mutual fund portfolios respond significantly to expected returns, portfolio frictions lead to a weaker and more gradual portfolio response to changes in expected returns. We also document heterogeneity across funds. Larger funds face bigger portfolio frictions, while small funds, more active funds and emerging market funds give relatively less weight to the buy-and-hold portfolio (rebalance more aggressively).

Date and time: 
Thursday 07 January 2021, 16:30
Organisation: 
National Bank of Belgium, KU Leuven, UAntwerpen, UCLouvain, UGent, ULB, ULiège, UNamur and VUB
Speaker(s): 
Philippe Bacchetta
Venue: 
Webinar
Entrance fee: 
free