DP8080 | Asset Prices, News Shocks and the Current Account

Publication Date

24/10/2010

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Abstract

We analyze the relationship between asset prices and current account positions estimating a Bayesian VAR for a broad set of 42 industrialized and emerging market countries. To derive model-based identifying restrictions, we model asset price shocks as news shocks about future productivity in a two-country DSGE model. Such shocks are found to exert sizeable effects on the current account positions of countries. Moreover, the effects are highly heterogeneous across countries, for instance following a 10 percent shock to domestic equity prices relative to the rest of the world the US trade balance will worsen by 1.0 percentage points, but much less so for most other economies. We find that this heterogeneity appears to be linked to the financial market depth and equity home bias of countries. Moreover, the channels via wealth effects and via the real exchange rate are important for understanding the heterogeneity in the transmission.