Time-Varying Preferences and International Capital Markets

Project Start: 01/2016
Status: Completed
Researchers: Giuliano Curatola, Ilya Dergunov
Category: Financial Markets, Household Finance
Funded by: LOEWE

This project was part of the team project "Social Finance – Finance and the Consumer".

Topic & Objectives

The traditional international finance literature assumes that preferences for traded goods are constant over time. ln this project we assume that investors' preferences are time-varying because they depend on the local popularity (in terms of sales) of internationally traded goods. 

We design a model with two countries, for brevity named home and foreign country. In each country, agents make consumption choices based on the local popularity of traded goods. Also, people are more sensitive to the popularity of the home good than to the popularity of the foreign good. For instance, the home agent Iooks at the popularity of the home good in the home country: If the popularity of the home good is high, the home agent increases her preference for the home good, decreases her preference for the foreign good and modifies her consumption basket accordingly. The agent will then select her optimal portfolio to finance the desired consumption plan. 

This mechanism helps explain several puzzles in the international finance Iiterature such as a Iack of risk sharing, a Iack of portfolio diversification and, more generally, fluctuations in asset prices and exchange rates.

We test our model empirically using data from the United States, the United Kingdom and Germany.

Key Findings 

  • Our anaIysis shows that time-varying preferences are a plausible driver of asset prices and exchange rates.
  • Time-varying preferences also forecast important macroeconomic variables, such as industrial production business confidence and consumer confidence.
  • These results suggest that time-variation in preferences is both theoretically and empirically important and, therefore, could represent an interesting avenue for future research.

 

Related Working Papers

No. Author/s Title Year Research Area Keywords
176 Giuliano Curatola, Ilya Dergunov International Capital Markets with Time-Varying Preferences 2017 Financial Markets, Household Finance Asset pricing, general equilibrium, heterogeneous agents, interdependent preferences, portfolio choice

 

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