Three Essays in International Macroeconomics and Finance

Abstract

In this dissertation, I study the changes in external liabilities and assets of emerging market economies since the early-2000s and the following implications of the changes for the financial stability and the optimal policies of the economies. In chapter 1, I construct a dataset, which measures the external liability composition of emerging market economies in different instruments and currencies. The new dataset shows emerging market economies have much lower currency exposures than in the past. Also, the observed pattern in the dataset suggests that the ever-increasing local currency external borrowings of the emerging market economies since the early 2000s, original sin dissipation, is related to the capital market development in emerging market economies. Chapter 2 is a study of channels through which risk-appetite shocks to global investors, i.e., global financial shocks, are transmitted to emerging market economies. First, I empirically show that much of the transmission of global financial shocks to emerging market economies is reflected in equity and local currency bond portfolio investment capital flows. I then develop a small open economy model which, augmented with leverage constrained banks and foreign investors who purchase equities and bonds, can replicate these empirical findings qualitatively. Quantitative analysis of the model suggests that global financial shocks can account for 50\% of the equity price volatility and 30\% of the investment volatility in Korea, in which most of the external liabilities of the country are Korean won-denominated equities and debts. In short, all the analysis in chapter 2 implies that to a substantial extent, risk-appetite shocks to global investors are transmitted to emerging market economies via fickle portfolio capital flows to equity and local currency bond markets in the economies. In chapter 3, Dongwook Kim and I provide a novel theory of international reserve accumulation of emerging market economies. We view reserve accumulation as capital outflows by the public sector which supplements insufficient capital outflows by the private sector. In our model, when an emerging market economy receives large capital inflows in the form of direct or equity portfolio investment, the emerging market economy must invest abroad to maintain macroeconomic balance and prepare for a possible future sudden stop. If the private sector in the emerging market economy cannot invest externally sufficiently or invests inefficiently due to low financial expertise or poor institutional quality, supplemental international investments must be accomplished by the public sector as international reserve outflows.