Aggregate Shocks, Idiosyncratic Shocks and Global Imbalances

Abstract

First part of my dissertation documents a positive correlation between changes in output volatilities and changes in net foreign asset positions for a sample of advanced economies. The correlation is robust to different measures of changes in volatility, to the inclusion of a large set of control variables, and to alternative estimation techniques. Given country specific characteristics, a one standard deviation increase in volatility generates a .21 percent increase in a country's ratio of net foreign asset position to GDP. In addition, the paper finds a clear channel from financial crises to changes in net foreign asset positions through changes in output volatilities, providing a strong empirical support for Bernanke's (2005) conjecture on the main causes for the emergence of a global saving glut. I build DSGE model to account for the relationship between volatility and NFA positions. The model explains around 25% of the change in NFA position for a representative country. Second part of my dissertation demonstrates that simultaneous changes in the volatility of uninsurable idiosyncratic risk across countries can explain the occurrence of global imbalances. I construct an international real business cycle model in which heterogeneous agents are not able to fully insure against aggregate and idiosyncratic shocks to labor earnings. First, I show that changes in idiosyncratic volatility can lead to much larger external imbalances than changes in aggregate volatility of the same magnitude. Second, I employ the Luxembourg Income Study dataset to measure changes in idiosyncratic risk for selected countries over the period 1980-2000, and use the results to calibrate the model. Under this approach, the model can quantitatively explain between 30 and 40 percent of the change in the U.S. net foreign asset position and comes close to explaining the change in Japan's net foreign asset position. The results are robust to different parameter values and model specifications.