Asset Prices, News Shocks, and the Trade Balance




  • We would like to thank two anonymous referees, and the participants at the conference on “Global Liquidity” at the Hong Kong Monetary Authority, the 2010 Bundesbank Spring Conference, Verein fuer Socialpolitik 2011, seminar participants at the Bank of England, as well as Gianluca Benigno, Luca Dedola, Philipp Harms, Akito Matsumoto, Gernot Mueller, Roberto Rigobon, John Rogers, Shang-Jin Wei, Ken West, and James Yetman for comments and discussion. The views expressed in this paper are those of the authors and do not necessarily reflect those of the European Central Bank.


We analyze the relationship between asset prices and the trade balance estimating a Bayesian VAR for a broad set of 38 industrialized and emerging market countries. To derive model-based identifying restrictions, we model asset price shocks as news shocks about future productivity in a two-country dynamic stochastic general equilibrium model. Such shocks are found to exert sizable effects on the trade balance. Moreover, the effects are highly heterogeneous across countries. For instance, following a news shock that implies on impact a 10% increase in domestic equity prices relative to the rest of the world, the U.S. trade balance will worsen by up to 1.0 percentage points, but much less so for most other economies. We find that this heterogeneity appears to be linked to the financial market depth and equity home bias of countries. Moreover, the channels via wealth effects and via the real exchange rate are important for understanding the heterogeneity in the transmission.