DP12783 BKK the EZ Way. International Long-Run Growth News and Capital Flows.

Author(s): Riccardo Colacito, Mariano Massimiliano Croce, Steven Ho, Philip Howard
Publication Date: March 2018
JEL(s): C62, F31, G12
Programme Areas: Financial Economics, International Macroeconomics and Finance, Macroeconomics and Growth
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12783

We study the response of international investment flows to short- and long-run growth news. Among developed G7 countries, positive long-run news for domestic productivity induces a net outflow of investments, in contrast to the effects of short-run growth shocks. We document that a standard Backus, Kehoe, and Kydland (1994) (BKK) model fails to reproduce this novel empirical evidence. We augment this model with Epstein and Zin (1989) preferences (EZ-BKK) and characterize the resulting recursive risk-sharing scheme. The response of international capital flows in the EZ-BKK model is consistent with the data.