Working Paper

A simple model of international capital flows, exchange rate risk, and portfolio choice

Abstract: This paper examines international capital flows in the context of a simple Diamond-Dybvig model in which there are neither moral hazard nor adverse selection problems, thus isolating exchange rate risk as the propagator of capital flows. The model shows that adverse changes in exchange rate expectations can result in \"hot money\" flows even when a bank's balance sheet is perfectly transparent and its assets have a positive net present value in local currency terms. The model also indicates that foreign deposit guarantees even in the absence of a change in the bank's portfolio can increase the chance of bank runs.

Keywords: Capital movements; Foreign exchange;

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2003

Number: 2000-009