Will a Deteriorating Current Account Increase Domestic Asset Price Fluctuation?—A Study Based on Mechanism and Time-Varying Effect of G20

ZhangMing, Liu Yao

Studies of International Finance ›› 2021, Vol. 0 ›› Issue (5) : 34-43.

Studies of International Finance ›› 2021, Vol. 0 ›› Issue (5) : 34-43.

Will a Deteriorating Current Account Increase Domestic Asset Price Fluctuation?—A Study Based on Mechanism and Time-Varying Effect of G20

  • ZhangMing1,3, Liu Yao2,3
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Abstract

Whether current account adjustment has significant effects on one country's asset price is an important issue to study and may be highly related to guarding financial risks.
To analyze whether the deterioration of a country's current account will increase domestic asset price fluctuation, this paper develops the Obstfeld and Rogoff (1996) model and the related Capital Asset Pricing Model. There are three key mechanisms that current account may affect asset price: cross-border capital flow mechanism, wealth effect mechanism and exchange rate mechanism. In the empirical analysis, this paper chooses G20 as samples, establishing dynamic panel regression and adopting time-varying parameter vector auto-regression (TVP-VAR) method to do empirical analysis.
The results demonstrate that: firstly, since the global financial crisis in 2008, the current account deterioration has not only led to the decline in the overall asset prices of G20, but also increased the volatility of domestic risk asset prices; secondly, the process of current account balance turning from surplus to deficit has a strong negative shock on asset prices; Thirdly, the impacts of current account deterioration on asset prices in the US, China, Japan and Germany have demonstrated significant heterogeneity and time-varying effects.
The conclusions have strong policy implications. Firstly, it is necessary to pay close attention to the direction and extent of current account adjustment, and make reasonable adjustment of economic policy. Secondly, policy makers need to pay close attention to the risk of frequent current account reversals to avoid the adverse impact of current account reversals on domestic asset prices and prevent the transformation of financial risks from external sectors to domestic sectors.

Key words

Current Account Deterioration / Asset Price Fluctuation / Financial Risk

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ZhangMing, Liu Yao. Will a Deteriorating Current Account Increase Domestic Asset Price Fluctuation?—A Study Based on Mechanism and Time-Varying Effect of G20[J]. Studies of International Finance, 2021, 0(5): 34-43

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