Download This PDF is a selection from a published volume from... Economic Research Volume Title: NBER International Seminar on Macroeconomics 2007

This PDF is a selection from a published volume from the National Bureau of
Economic Research
Volume Title: NBER International Seminar on Macroeconomics 2007
Volume Author/Editor: Richard Clarida and Francesco Giavazzi, organizers
Volume Publisher: University of Chicago Press
ISSN: 1932-8796
Volume URL: http://www.nber.org/books/clar07-1
Conference Date: June 15-16, 2007
Publication Date: January 2009
Chapter Title: Comment on "International Portfolios with Supply, Demand and
Redistributive Shocks"
Chapter Author: Refet S. Gürkaynak
Chapter URL: http://www.nber.org/chapters/c3011
Chapter pages in book: (277 - 281)
Comment
Refet S. Gurkaynak,BilkentUniversityandCEPR
Introduction
Researchon internationalportfolioholdings and flows have been reenergized with the introductionof data on gross portfolio holdings and
analyticalmethods to solve for financialholdings in models with incompletemarkets.This paper adds to that literatureby addressingtwo
of the most interestingstylized facts, described in the following, from
within an innovativemodeling framework.It is an importantpaperthat
asks the right questions and provides an initial answer using novel
model solution methods.
My discussion will first point out the modeling devices that help the
authorsexplainthe stylized factsand then presenta briefnote on the calculationof the labor share,the varianceof which is used in the calibration of the model.
Stylized Factsand the Model
The paper,beginning with the abstract,mentions three stylized facts of
industrialized economies to be explained: (a) portfolio holdings are
biased toward local equity; (b) internationalportfolios are long in foreign currencyassets and short in domestic currency;and (c) the depreciationof a country'sexchangerateis associatedwith net externalcapital gains. There are actually two stylized facts to be explained as (c) is
directlyimpliedby (b).If a countryis long in foreigncurrencyassets and
short in domestic ones, a depreciationof its own currencywill lead to
capital gains on those holdings. Indeed, the authors only focus on obtaining(b)as a model predictionand treat(c)as being obviously implied
by this.
Themodel is presentedin two steps. First,thereis a completemarkets
278
Gurkaynak
version with two shocks and two assets that builds intuition into the
workings of the mechanisms.Then a third shock is introduced,leading
to marketincompleteness,in which case the model is solved using the
Devereux and Sutherland(2006)method. The qualitativepredictionsof
the model are developed in the complete marketscase, on which I will
elaborate.
In the completemarketscase thereare two assets,equities and bonds,
and two shocks:a relativedemand shock for the goods producedby the
home or foreign countries and a redistributiveshock that changes the
accrualof income between laborand capitalwithin the country.The redistributiveshockexplainsthe home bias in equitiesbecausethe income
risk to workersdue to this shock is hedged by holding claims on the return to domestic capital.In the state of the world where the redistributive shock transfersincome from labor to capital the workers are perfectly hedged as they still receive the same income, this time in the form
of capitalincome due to theirdomestic equity holdings.
The demand shock, on the other hand, explains the second stylized
fact. The demand shock essentially redistributesincome across home
and foreign countriesand having claims on the foreigncountryhedges
this risk.An importantcontributionof the paper is showing thatin general a supply shock would not lead to the same predictiondue to terms
of tradeeffects.
Whilethe two shocksqualitativelyexplainthe two stylized factsin the
completemarketscase, it is worthwhile to note thatthereis no interplay
between these two in this case. The optimal portfolioholding response
to the existence of one of the shocks (redistributive)explains the home
bias in equities, while the response to the other (demand)explains the
net long foreign currencyholdings. Thus, the complete markets case
presents a model with two separatechannelsoperatingindependently,
which is educative but is not completely satisfying. The model in this
case also predictsextremeportfoliochoices such as completehome bias
in equities.
Tohave more interplaybetween the responses to the two shocks and
to generate quantitativemodel predictions that are more in line with
what is observedin the data,the authorsmove to an incompletemarkets
settingby introducinga supply shock.Withtwo assets and threeshocks,
marketsare incompleteand gross portfolioholdings are difficultto pin
down. This difficulty is overcome with a very nice application of the
Devereux-Sutherlandsolution method.
The downside of the Devereux-Sutherlandsolution, which involves
Comment
279
using a second-orderapproximation,is that it makes intuitionbuilding
more difficult. While in the complete markets case it was clear which
part of the model played which role in the results, this is no longer the
case in the incompletemarketscase. In particular,what exactlyis the interplaybetween the threetypes of shocksthatlead to the particularportfolio holdings?Understandingthe natureof the interplaybetween these
shocks and the portfolio holdings they give rise to will surely lead to
more work in this field. In thatregard,this paperhas opened the door to
a very interestingand potentially rewarding researchavenue in internationalfinance.
Calculationof the LaborShare
Only in the incomplete markets case can the model be sensibly calibrated as the complete marketsassumption leads to strong and counterfactualquantitativepredictions. The calibrationin the incomplete
marketscase uses time variationin the labor share,calculatedfrom national statistics, to pin down the variance of the redistributiveshock.
This may be problematicfor two reasons.
Attributing the interpretationof a redistributive shock to annual
changes in the labor share is similar to trying to measure fundamental
totalfactorproductivity(TFP)changesfromannualSolow residuals.Although over long periods of time (e.g., five or ten years)this may be reasonable, there are too many measurement issues that complicate the
analysis at higher frequencies. Changes in reporting practices, labor
hoarding,and so forth,all affectthe measuredlaborshare,given thatthe
variationin this is small to begin with, it is hard to be sure that not all of
the annualvariationis due to measurementissues.
A second, more fundamentalissue with the way this paper measures
the laborshare is that it defines the laborincome as only compensation
of employees. Thatis,
LaborShare = Compensationof EmployeesI {GD?-IndirectTaxes).
Buteven in industrializedcountriesnot all laboris employee labor.Part
of the laborincome falls under the operatingsurplus of unincorporated
enterprises(OSPUE)heading.As an example,table5C2.1shows the cost
componentsof GDP in Italyin 1991.
The operating surplus of unincorporatedenterprises in (4b) is the
mom and pop stores' (small firms, as opposed to corporations)profits.
As the owners'do not pay themselveswages, this proprietors'income is
280
Giirkaynak
partly labor income. This is a nontrivialpart of the GDP- more than a
quarterof the GDP is OSPUE- and not capturingthis will cause under
measuringthe laborshare.
This observation led Gollin (2002) and Bernanke and Giirkaynak
(2001)to look for ways of dividing the OSPUEbetween laborand capital. One way of doing this is to assume the labor share in OSPUEis the
same as in the rest of the economy.Anotherway is looking at the composition of the laborforce and inflatingthe employee compensationby
the fractionof the laborforcethat are not employees. Table5C2.2shows
the laborforce compositionin Italyin 1991.
As canbe seen, employees makeup only about70 percentof the workforce,with the remaining30 percent'slaborincomebeing excludedfrom
the labor share calculatedfrom employee compensationonly. The Italian labor share calculatedthis way is only 0.5, while it is a much more
reasonable0.65 to 0.7 when correctedfor the labor income of the nonemployees.
The currentpaper uses the standard deviation of the labor share to
calibratethe variance of the redistributiveshock. Thus, mismeasuring
its level may not be an issue by itself. However,both the shareof the opTable5C2.1
Cost componentsof GDP,Italy1991
1. Indirecttaxes,net
2. Consumptionof fixed capital
3. Compensationof employeesby residentproducers
4. Operatingsurplus
4a. Corporateand quasi-corporateenterprises
4b. Privateunincorporatedenterprises
4c. Generalgovernment
5. GrossDomesticProduct
133,361
168,539
647,792
477,879
71,312
403,714
2,853
1,427,570
Source:UN NationalAccountsStatistics
Table5C2.2
Laborforcecomposition,Italy1991
Employersand own acct.workers
Employees
Unpaidfamilyworkers
Not classifiableby status
Total
Source:ILOYearbookof LaborStatistics
5,228,000
15,478,000
886,000
2,653,000
24,245,000
International
PortfolioswithSupply,Demand,andRedistributive
Shocks 281
erating surplus in GDP and the compositionof the laborforceshow annual time variationof the same orderof magnitudeas the varianceof the
laborsharecalculatedby the authors.Thatsuggests that calibratingthe
variance of the redistributiveshock this way and from highly aggregated data, independently of whether such a shock is theoreticallyappealing or not, may not be very appropriate.
Conclusion
This paper identifies some of the most importantopen questions in
the literatureand shows how new modeling devices can be used to provide answersto them.Whilethereareissues aboutthe modeling choices
and calibrationpreferences, this way of thinking about the relevant
questions will surely lead to more researchon these topics and a better
understandingof internationalportfolio holdings. Researchthat especially asks how much of the observedportfoliochoices can be explained
solely by hedging behavior, as in this paper (as opposed to informational and otherissues) would be most welcome. Such researchwill undoubtedlybenefitfromthe model and insights provided by this paper's
authors.
References
Bernanke, B., and R. Gurkaynak. 2001. Is growth exogenous? Taking Mankiw, Romer, and
Weil seriously. In NBERMacroeconomicsAnnual Vol. 16, 11-57. Cambridge, MA: MIT Press.
Devereux, M., and A. Sutherland. 2006. Solving for country portfolios in open economy
macro models. University of British Columbia. Working Paper.
Gollin, D. 2002. Getting income shares right. Journalof Political Economy110 (2): 458-74.