International Portfolios, Trade Imbalances and the Exchange Rate

Abstract

Establishing a two-country, two-good, two-money, two-bond continuous-time dynamic portfolio model of international investor, this paper firstly demonstrates that since monies as well as bonds issued in different countries are not perfectly substitutive for each other none of them should be generally ignored in analyzing the exchange rate determination. Then, it presents the general equilibrium conditions of international asset markets considering goods trade imbalances and derives the equilibrium exchange rate. Finally it investigates the effects of large and marginal changes in money supplies, bond supplies and goods trade imbalances on the exchange rate.